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    Capital Structure Calculations with MM Model

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    Use the appropriate MM model to evaluate the following: an unlevered
    firm (Firm U) has a market value of $45 million, a tax rate of 40%,
    and expected EBIT of $9 million. A levered firm (Firm L) is
    identical to Firm U (same tax rate, same EBIT) except Firm L has
    outstanding 8% debt of $18 million.

    The weighted average cost of capital for Firm U is

    a. 5.00%
    b. 8.00%
    c. 12.00%
    d. 15.00%
    e. 20.00%

    The cost of equity for firm U is

    a. 5.00%
    b. 8.00%
    c. 12.00%
    d. 15.00%
    e. 20.00%

    The weighted average cost of capital for Firm L is

    a. 8.00%
    b. 10.34%
    c. 12.00%
    d. 17.24%
    e. 18.00%

    The cost of equity for firm L is

    a. 8.00%
    b. 11.25%
    c. 12.00%
    d. 13.26%
    e. 16.85%

    The market value of Firm L is

    a. $65,000,000
    b. $63,000,000
    c. $52,200,000
    d. $18,000,000
    e. $ 9,000,000

    Has Firm L benefited from the use of leverage? Why or why not?

    a. Yes because VL > VU
    b. No because VL > VU
    c. Yes because rAL > rAU
    d. No because rAL > rAU
    e. In fact, only answers (a) and (c) are correct

    © BrainMass Inc. brainmass.com June 4, 2020, 12:24 am ad1c9bdddf
    https://brainmass.com/business/weighted-average-cost-of-capital/capital-structure-calculations-mm-model-336205

    Solution Summary

    The solution explains some multiple choice questions relating to WACC, cost of equity, market value and use of leverage

    $2.19

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