MM in a perfect market

MM in a perfect market

1. 1. MM Proposition I (no taxes, no distress, no agency, no info asymmetry) says:

   Firm value V_L = V_U; capital structure is irrelevantFirms should be 100% debt to maximize valueFirms should be 100% equity to minimize riskCost of equity equals cost of debt

2. 2. Unlevered cost of capital r_U = 12%. Cost of debt r_D = 5%. The firm has D/E = 0.5 (no taxes). What is the cost of equity per MM II? Answer as a percent.

   %

3. 3. Under MM (no taxes), what is WACC at the cost of equity above (D/E = 0.5, r_U=12%, r_E=15.5%, r_D=5%, D/V=1/3)?

   10%11%12%13%

4. 4. Which assumptions does MM I rely on (so its violations are what drive real-world capital structure)?

   No corporate taxesNo bankruptcy / distress costsPerfect information / no asymmetric infoRisk-free borrowing for everyone at the same rate