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Companies U and L are identical in every respect except that U is unlevered while L has $12 million of 7% bonds outstanding

Finance

Companies U and L are identical in every respect except that U is unlevered while L has $12 million of 7% bonds outstanding. Assume that all of the original M&M assumptions are met, that EBIT is $3 million for both companies and that the cost of equity to company U is 9%. If there are no corporate or personal income taxes what is the M&M value for firm U.

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Computation of the value of firm U:-

Value of Firm U (Vu) = EBIT * (1 - Tax rate) / Unlevered cost of equity

= $3 * (1 - 0%) / 9%

$33.33 million