Question: Firms U and L are identical except that Firm U is financed with 100% equity while Firm L has $10 million of 5% bonds. Assume

Firms U and L are identical except that Firm U is financed with 100% equity while Firm L has $10 million of 5% bonds. Assume that all of the MM assumptions are met, EBIT is $2 million and the cost of equity to Firm U is 10%.

a. Assume that there are no corporate or personal taxes,

1. What would be the value of the Firm U and Firm L according to MM?

2. What is r_s for Firm U and r_s for Firm L?

b. Assume that both firms are subject to a 40% corporate tax rate

1. What would be the value of the Firm U and Firm L according to MM?

2. What is r_s for Firm U and r_s for Firm L?

c. Assume that both firms are subject to a 40% corporate tax rate and the personal tax rate is 28% on debt income and 20% on stock income.

1. What would be the value of the Firm U and Firm L according to Miller?

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