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What is the WACC for High Leverage Inc

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Question - Two firms, No Leverage Inc. and High Leverage, Inc., have equal amounts of operating risk and differ only in their capital structures. No Leverage is unlevered, with a cost of equity of 10%, and High Leverage has $400,000 of perpetual debt in its capital structure (cost of debt 6%). Assume that the perpetual amount of income of both firms available for stockholders is paid out as dividends, hence, the growth rate for both firms is zero. EBIT for both companies is $100,000. The corporate tax rate is 34 percent. Assume there are no bankruptcy or agency costs associated with debt financing.

Required -

a) Determine the market value of High Leverage, Inc.

b) Determine the market value of equity for High Leverage, Inc. What is the relationship between the value of the unlevered firm and the value of a levered firm once we consider the effect of corporate income taxes?

c) In a Modigliani & Miller world with corporate taxes, what is the cost of equity for High Leverage, Inc.? What is the WACC for High Leverage, Inc.?

Reference no: EM132621782

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