Situation $(2)$

David Lyons, the CEO of Lyons Solar Technologies, is concerned about his firm's level of debt financing. The company uses shortterm debt to finance its temporary working capital needs, but it does not use any permanent $($long$-$term$)$ debt. Other solar technology companies average about $30$ percent debt, and Mr$.$ Lyons wonders why the difference occurs, and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant.

Business Week recently ran an article on companies' debt policies, and the names Modigliani and Miller $($MM$)$ were mentioned several times as leading researchers on the theory of capital structure. Briefly, who are MM$,$ and what assumptions a reembedded in the MM and Miller models?

Assume that Firms $U$ and $L$ are in the same risk class, and that both have EBIT $=$$$500,000.$ Firm Uses no debt financing, and its cost of equity is rsU$=14\%.$ Firm $L$ has $$1$ million of debt outstanding at a cost of $rd=8\%.$ There are no taxes. Assume that the MM assumptions hold, and then:

Find V$,$ S$,$ rs$,$ and WACC for Firms U and L$.$

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.