The following data relate to two companies belonging to the same risk class: Particulars A Ltd. B Ltd. Expected Net Operating Income 18,00,000…

(a) Assuming no tax as per MM Approach. Calculation of Value of Firms 'A Ltd.' and 'B Ltd' according to MM Hypothesis Market Value of 'B Ltd' [Unlevered(u)] Total Value of Unlevered Firm (Vu) = [ NOI/ke] Vu = 18,00,000 / 0.18 Vu = 1,00,00,000 Ke of Unlevered Firm (given) = 0.18 Ko of Unlevered Firm (Same as above = ke as there is no debt) = 0.18 Market Value of 'A Ltd' [Levered Firm (I)] Total Value of Levered Firm (VL) = Vu + (Debt × Nil) VL = 1,00,00,000 + (54,00,000 × nil) VL = 1,00,00,000 Computation of Equity Capitalization Rate and Weighted Average Cost of Capital (WACC) Particulars A Ltd. B Ltd. A Net Operating Income (NOI) 18,00,000 18,00,000 B Less: Interest on Debt (I) 6,48,000 - C Earnings of Equity Shareholders (NI) 11,52,000 18,00,000 D Overall Capitalization Rate (ko) 0.18 0.18 E Total Value of Firm (V = NOI/ko) 1,00,00,000 1,00,00,000 F Less: Market Value of Debt 54,00,000 - G Market Value of Equity (S) 46,00,000 1,00,00,000 H Equity Capitalization Rate [ke = NI /S] 0.2504 0.18 I Weighted Average Cost of Capital [WACC] (ko) 0.18 0.18 Assuming 40% taxes as per MM Approach Calculation of Value of Firms 'A Ltd.' and 'B Ltd' according to MM Hypothesis Approach Market Value of 'B Ltd' [Unlevered(u)] Total Value of unlevered Firm (Vu) = [NOI(1 - t)/ke] Vu = 18,00,000 (1 - 0.40) / 0.18 Vu = 60,00,000 Ke of unlevered Firm (given) = 0.18 Ko of unlevered Firm (Same as above = ke as there is no debt) = 0.18 Market Value of 'A Ltd' [Levered Firm (I)] Total Value of Levered Firm (VL) = Vu + (Debt × Tax) VL = 60,00,000 + (54,00,000 × 0.40) VL = 81,60,000 Computation of Weighted Average Cost of Capital (WACC) of 'B Ltd.' WACC = 18% (i.e. Ke = Ko) Computation of Equity Capitalization Rate and Weighted Average Cost of Capital (WACC) of A Ltd Particulars A Ltd. Net Operating Income (NOI) 18,00,000 Less: Interest on Debt (I) 6,48,000 Earnings Before Tax (EBT) 11,52,000 Less: Tax @ 40% 4,60,800 Earnings for equity shareholders (NI) 6,91,200 Total Value of Firm (V) as calculated above 81,60,000 Less: Market Value of Debt 54,00,000 Market Value of Equity (S) 27,60,000 Equity Capitalization Rate [ke = NI/S] 0.2504 Weighted Average Cost of Capital (ko)* 13.23 *Computation of WACC A Ltd Component of Capital Amount Weight Cost of Capital WACC Equity 27,60,000 0.338 0.2504 0.0846 Debt 54,00,000 0.662 0.072* 0.0477 Total 81,60,000 0.1323 *Kd = 12% (1-0.4) = 12% × 0.6 = 7.2% WACC = 13.23%