Question: Two firms U and L differ only in their capital structure. Firm U has a market value of $30,000, with no debt, whilst firm L

Two firms U and L differ only in their capital structure. Firm U has a market value of $30,000, with no debt, whilst firm L has employed $15,000 in debt at the risk-free interest rate of 5% per annum. The expected net operating income of both firms is $7,000 per annum in perpetuity, and the corporate tax rate is 30%.

i) Show that the market value of the equity of Firm L is $19,500.

ii) Calculate the equity holders after-tax required rate of return for both firms.

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