The following information is given for 3 companies that are identical except for their capital structure: Orange Grape Apple Total invested capital…

(i) Calculation of WACC of each company Orange Grape Apple Total debt (₹) 80,000 50,000 20,000 Post tax Cost of debt 10.40% 8.45% 9.75% Equity Fund (₹) 20,000 50,000 80,000 WACC Orange: (10.4 x 0.8) + (26 x 0.2) = 13.52% Grape: (8.45 x 0.5) + (22 x 0.5) = 15.225% Apple: (9.75 x 0.2) + (20 x 0.8) = 17.95% (ii) Economic Valued Added (EVA) of each company Orange Grape Apple WACC 13.52 15.225 17.95 EBIT (1-T) (A) 16,250 16,250 16,250 WACC x Invested Capital (B) 13,520 15,225 17,950 EVA [(A) – (B)] 2,730 1,025 -1,700 Orange would be considered as the best investment since the EVA of the company is highest and its weighted average cost of capital is the lowest. (iii) No. of shares issued by each company Orange Grape Apple EBIT (₹) 25,000 25,000 25,000 Interest (₹) 12,800 6,500 3,000 Taxable Income (₹) 12,200 18,500 22,000 Tax 35% (₹) 4,270 6,475 7,700 Net Income (₹) 7,930 12,025 14,300 Stock Price (EPS x PE Ratio) (₹) 14.30 15.95 15.73 No. of shares (7930x11)/14.30 = 6100 (12025x11)/15.95 = 8293 (14300x11)/15.73 = 10000 (iv) Since the three entities have different capital structures, they would be exposed to different degrees of financial risk. The PE ratio should therefore be adjusted for the risk factor. (v) Market Capitalisation Orange Grape Apple Estimated Stock Price (₹) 14.30 15.95 15.73 No. of shares 6,100 8,293 10,000 Estimated Market Cap (₹) 87,230 1,32,273.35 1,57,300