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…

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 (V u ) = [NOI (1 - t)/k e ] = 18,00,000(1 – 0.40)] / 0.18 = 60,00,000 K e of unlevered Firm (given) = 0.18 K o of unlevered Firm (Same as above = k e as there is no debt) = 0.18 Market Value of 'A Ltd' [Levered Firm (l)] Total Value of Levered Firm (V L ) = V u + (Debt× Tax) = 60,00,000 + (54,00,000 × 0.40) = 81,60,000 Computation of Weighted Average Cost of Capital (WACC) of 'B Ltd.' = 18% (i.e. K e = K o ) 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 [k e = NI/S] 0.2504 Weighted Average Cost of Capital (k o )* 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 *K d = 12% (1-0.4) = 12% × 0.6 = 7.2% WACC = 13.23%