Please solve parts c and d using the information from part b

B. 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, and then:

1. Find v, s, rs, and WACC for firms U and L.

2. Graph (a) the relationships between capital costs and leverage as measured by D/V, and (b) the relationship between value and D.

V of firm U: EBIT/required rate of return (assuming that there are no taxes)

= 500,000/14%

= 3,571,428.57

V of firm L will be the same as V of form U. Thus V of L = 3,571,428.57

Next we have to find rsL. We know that D+SL = VL or SL = VL-D

Thus SL = 3,571,428.57 - 1,000,000 = $2,571,428.57

Now rsL = rsU+(rsU-rd)*(D/S)

= 14%+(14%-8%)*(1,000,000/2,571,428.57)

= 16.33%

Now as per MM proposition WACC = wd*rd+wce*rs = (D/V)*rd+(S/V)*rs

= (1,000,000/3,571,428.57)*8% + (2571428.57/3571428.57)*16.33%

= 14%

a. Relationship between the capital costs and leverage is shown in the graph below:

C. Using the data given in part B, but now assuming that firms L and U are both subject to a 40 percent corporate tax rate, repeat the analysis called for in B(1) and B(2) under the MM with-tax model.

D. Now suppose investors are subject to the following tax rates: TD = 30% and Ts = 12%

1. What is the gain from leverage according to the Miller Model?

2. How does this gain compare to the gain in the MM model with corporate taxes?

3. What does the Miller model imply about the effect of corporate debt on the value of the firm, that is, how do personal taxes affect the situation?