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Companies u and l are identical in every respect except

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Companies U and L are identical in every respect except that U is unlevered while L has $10 million of 5% bonds outstanding. Assume that (1) all of the MM assumptions are met, (2) both firms are subject to a 40% federal-plus-state corporate tax rate, (3) EBIT is $2 million, (4) Investors in both firms face a tax rate of Td = 28% on debt income and Ts = 20% (on average) on stock income, and (5) the appropriate required pre-personal-tax rate rsU is 10%.

a. What is the value V, of the unlevered firm? (Note that Vu is now reduced by the personal tax on stock income, so VU = $12 million as in Problem 26-6.)

b. That is the value of VL?

c. What is the gain from leverage in this situation? Compare this with the gain from leverage in Problem 26-6.

d. Set Tc = Ts = Td = 0. What is the value of the levered firm? The gain from leverage?

e. Now suppose Ts = Td = 0 and Tc = 40%. What are the value of the levered firm and the gain from leverage?

f. Assume that Td = 28%, Ts = 28%, and Tc = 40%. Now what arc the value of the levered firm and the gain from leverage?

Reference no: EM13484888

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