fm17 5 - b. r sU = 10.0%. (Given) r sL = r sU + (r sU- r d...

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
d. $6 Million Debt: V L = $8.0 + 0.40($6) = $10.4 million. r sL = 15.625% + 5.625%(0.60)($6/$4.4) = 20.23%. The mathematics of MM result in the required return, and, thus, the same financial risk premium. However, the market value debt ratio has increased from $6/$11.5 = 52% to $6/$10.4 = 58% at the higher tax rate. Hence, a higher tax rate reduces the financial risk premium at a given market value debt/equity ratio. This is because a higher tax rate increases the relative benefits of debt financing. 17-5 a. V U = sU r EBIT = 10 . 0 million 2 $ = $20 million.
Background image of page 1
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: b. r sU = 10.0%. (Given) r sL = r sU + (r sU- r d )(D/S) = 10% + (10% - 5%)($10/$10) = 15.0%. c. S L = sL d r D r EBIT = 15 . ) 10 ($ 05 . 2 $ = $10 million. S L + D = V L = V U + TD. $10 + $10 = $20 = V L = $20 + (0)$10 = $20 million. d. WACC U = r sU = 10%. For Firm L, we know that WACC must equal r sU = 10% according to Proposition I. But, we can demonstrate this as follows: WACC L = (D/V)r d + (S/V)r s = ($10/$20)5% + ($10/$20)15% = 2.5% + 7.5% = 10.0%. Answers and Solutions: 17 - 5...
View Full Document

Ask a homework question - tutors are online