The following data relates to two companies belonging to the same risk class: Particulars A Ltd. B Ltd. Expected Net Operating Income 19,00,000…

(b) (i) 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] = 19,00,000 / 0.19 = 1,00,00,000 Ke of Unlevered Firm (given) = 0.19 Ko of Unlevered Firm (Same as above = Ke as there is no debt) = 0.19 Market Value of 'A Ltd' [Levered Firm (l)] Total Value of Levered Firm (VL) = Vu + (Debt × Nil) = 1,00,00,000 + (57,00,000 × nil) = 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) 19,00,000 19,00,000 B. Less: Interest on Debt (I) 6,84,000 - C. Earnings of Equity Shareholders (NI) 12,16,000 19,00,000 D. Overall Capitalization Rate (ko) 0.19 0.19 E. Total Value of Firm (V = NOI/ko) 1,00,00,000 1,00,00,000 F. Less: Market Value of Debt (D) 57,00,000 - G. Market Value of Equity (S) 43,00,000 1,00,00,000 H. Equity Capitalization Rate [ke = NI /S] 0.2828 0.19 I. Weighted Average Cost of Capital [WACC (ko)]*ko = (ke×S/V) + (kd×D/V) 0.19 0.19 *Computation of WACC A Ltd. Component of Capital Amount Weight Cost of Capital WACC Equity 43,00,000 0.43 0.2828 0.1216 Debt 57,00,000 0.57 0.12* 0.0684 Total 1,00,00,000 0.19 *Kd = 12% (since there is no tax) WACC = 19% (ii) Assuming 40% taxes 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 (1 - t)/ke] = [19,00,000 (1 – 0.40)] / 0.19 = 60,00,000 Ke of unlevered Firm (given) = 0.19 Ko of unlevered Firm (Same as above = Ke as there is no debt) = 0.19 Market Value of 'A Ltd' [Levered Firm (l)] Total Value of Levered Firm (VL) = Vu + (Debt× Tax) = 60,00,000 + (₹ 57,00,000 × 0.4) = 82,80,000 Computation of Weighted Average Cost of Capital (WACC) of 'B Ltd.' = 19% (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) 19,00,000 Less: Interest on Debt (I) 6,84,000 Earnings Before Tax (EBT) 12,16,000 Less: Tax @ 40% 4,86,400 Earnings for equity shareholders (NI) 7,29,600 Total Value of Firm (V) as calculated above 82,80,000 Less: Market Value of Debt 57,00,000 Market Value of Equity (S) 25,80,000 Equity Capitalization Rate [ke = NI/S] 0.2828 Weighted Average Cost of Capital (ko)* 13.77% ko = (ke×S/V) + (kd×D/V) *Computation of WACC A Ltd. Component of Capital ₹ Weight Cost of Capital WACC Equity 25,80,000 0.312 0.2828 0.0882 Debt 57,00,000 0.688 0.072* 0.0495 Total 82,80,000 0.1377 *Kd = 12% (1-0.4) = 12% × 0.6 = 7.2% WACC = 13.77%