(a) Following data is available in respect of two companies having same business risk: Sources A Ltd B Ltd Levered Company (₹) Unlevered Company (₹)…

PART II - Descriptive Questions Valuation of firms Particulars A Ltd B Ltd Levered Firm (₹) Unlevered Firm (₹) EBIT 45,000 45,000 Less: Interest on debt (10% × ₹1,50,000) 15,000 Nil Earnings available to Equity shareholders 30,000 45,000 K e 12.5% 12.5% Value of Equity (S) 2,40,000 3,60,000 (Earnings available to Equity shareholders/ K e ) Debt (D) 1,50,000 Nil Value of Firm (V) = S + D 3,90,000 3,60,000 Value of Levered company is more than that of unlevered company. Therefore, investor will sell his shares in levered company and buy shares in unlevered company. To maintain the level of risk he will borrow proportionate amount and invest that amount also in shares of unlevered company. (ii) Investment & Borrowings Sell shares in Levered company (₹2,40,000 x 20%) 48,000 Borrow money (₹1,50,000 x 20%) 30,000 Buy shares in Unlevered company 78,000 (iii) Change in Return Income from shares in Unlevered company (₹78,000 x 12.5%) 9,750 Less: Interest on loan (₹30,000 x 10%) 3,000 Net Income from unlevered firm 6,750 Less: Income from Levered firm (₹48,000 x 12.5%) 6,000 Incremental Income due to arbitrage 750