Response to the following problem:
Companies U and L are identical in every respect except that U is unlevered while L has $10 million of 5 percent bonds outstanding.
Assume (1) that all of the MM assumptions are met, (2) that there are no corporate or personal taxes, (3) that EBIT is $2 million, and (4) that the cost of equity to Company U is 10 percent.
a. What value would MM estimate for each firm?
b. What is rs for Firm U? For Firm L?
c. Find SL, and then show that SL D VL $20 million.
d. What is the WACC for Firm U? For Firm L?
e. Suppose VU $20 million and VL $22 million.
According to MM, do these values represent an equilibrium? If not, explain the process by which equilibrium would be restored.