Hi, Just a quick question--- Suppose there are two firms (A & B) with similar business risks. Risk free rate and Market risk premium are given. I also have Firm B's Levered Beta, Capital Structure, Tax rate and cost of debt. For Firm A, I only have the capital structure, tax rate and cost of debt. Given that they have the same business risk, I am unlevering B's levered beta. Then, I am using B's unlevered beta and applying A's capital structure to find A's levered beta. When I use A's target capital structure, to get required rate of return on equity, I get a different answer from Modigliani Miller's Method II, with corporate tax.
Modigliani Miller's Method II states that, required rate of return on equity= unlevered rate of return + debt to equity ratio* (cost of unlevered equity- cost of debt) *(1-Tax rate)
Using different required rate of return on equity, I get a different valuation. Am I doing something wrong? Essentially, both methods should give me the same number. I would really appreciate if anyone could help! Cheers!
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