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Capital Structure Calculations with MM Model

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

Solution Summary

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

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