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Problem:
You are considering two identical firms, one levered and the other unlevered. Both firms have expected EBIT of $33,000. The value of the unlevered firm (VU) is $110,000. The corporate tax rate is 30%. The cost of debt is 12%, and the ratio of debt to equity is 1 for the levered firm.
Use MM propositions in a world without bankruptcy to answer the following questions.
(a) Calculate the cost of equity for both the levered and unlevered firms.
(b) Calculate the WACC for both firms.
(c) Why is the cost of equity higher for the levered firm, but the WACC lower?
(d) What is the value of the levered firm?
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