A company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies average about 30% debt.
Assume that firms U and L are in the same risk class, and that both have EBIT = $500,000. Firm U uses no debt financing, and its cost of equity is rsU = 14%. Firm L has $1 million of debt outstanding at a cost of rd = 8%. There are no taxes. Assume that the MM assumptions hold.
1. Find v, s, rs, and WACC for firms U and L.
2. What is the current total value? The tax rate and unlevered cost of equity remain at 40% and 14%, respectively.
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