Question 1 :: Compute the market value of the firm, value of shares and the aver
ID: 2772287 • Letter: Q
Question
Question 1 :: Compute the market value of the firm, value of shares and the average cost of capital from the following information.
Net operating income Rs. 2, 00,000
Total investment Rs. 5, 00,000
Equity capitalization Rate:
(a) If the firm uses no debt 10%
(b) If the firm uses Rs. 25,000 debentures 11%
(c) If the firm uses Rs. 4, 00,000 debentures 13%
Assume that Rs. 5, 00,000 debentures can be raised at 6% rate of interest whereas
Rs. 4, 00,000 debentures can be raised at 7% rate of interest.
Explanation / Answer
a) Full Equity Equity capitalisation rate(WACC) 10% Value of firm= NOI / WACC ie. 200000/0.1= Rs. 2000000 Value of shares 500000 (Full Equity) Average cost of capital 10% b) Rs. 25000 debentures in capital structure Equity capitalisation rate 11% Value of firm= NOI / WACC ie. 200000/0.1045= 1913875.598 Value of shares 475000 Amount Weight Cost Wt.*Cost Debentures 25000 0.05 Equity 475000 0.95 0.11 0.1045 Total Investment 500000 1 Average cost of capital 10.45% c) Rs. 400000 7%debentures in capital structure Equity capitalisation rate 13% Value of firm= (NOI-Deb.int.) / WACC ie. (200000-(400000*7%))/0.082= 2097560.976 Value of shares 100000 Amount Weight cost Wt.*Cost Deb. 400000 0.8 0.07 0.056 Equity 100000 0.2 0.13 0.026 Total Inv. 500000 1 0.082 Average cost of capital 8.20%
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