{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

# fm17 5 - b r sU = 10.0(Given r sL = r sU(r sU r d(D/S =...

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

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.
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

{[ snackBarMessage ]}

Ask a homework question - tutors are online