fm17 15 - Assume that the MM assumptions hold and then 1...

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These assumptions--all of them--were necessary in order for MM to use the arbitrage argument to develop and prove their equations. If the assumptions are unrealistic, then the results of the model are not guaranteed to hold in the real world. b. Assume that firms U and L are in the same risk class, and that both have EBIT = $500,000. Firm U uses no debt financing, and its cost of equity is r sU = 14%. Firm L has $1 million of debt outstanding at a cost of r d = 8%. There are no taxes.
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Unformatted text preview: Assume that the MM assumptions hold, and then: 1. Find v, s, r s , and WACC for firms U and L. Answer: First, we find Vu and V L : V U = sU r EBIT = 14 . 000 , 500 $ = $3,571,429. V L = V U = $3,571,429. To find r sL , it is necessary first to find the market values of firm L’s debt and equity. The value of its debt is stated to be $1,000,000. Therefore, we can find s as follows: D + S L = V L S L = V L- D = $3,571,429 - $1,000,000 = $2,571,429. Mini Case: 17 - 15...
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