Reference no: EM133419521

Question: The following information relates to two companies operating in the freight transport industry. The companies enjoy the same business risk and are identical in all material respects except for their capital structures, which are as follows:

Kasper plc	Market Value (£000)
Equity: 175,000 ordinary shares of £1 each	250
Debt: £125,000 5% Debentures	100
	350
Torben plc	Market Value (£000)
Equity: 250,000 ordinary shares of £1 each	300

The usual pre-interest profit for both companies is £100,000 per annum, and, as a matter of policy, both companies distribute any residual profit as dividends.

Required: show stepes

(a) Calculate the maximum capital gain that can be realised by a holder of 1% of the equity in Kasper plc, whilst maintaining both their income and their exposure to risk;

(b) Show that your scheme maintains the income of the investor in (a);

(c) Show that your scheme maintains the exposure to risk of the investor in (a) by considering the effect on their income if the pre-interest profit of both Kasper plc and Torben clc fall by 10%;

(d) Identify and discuss critically the assumptions that you have made in answering part (a) above;

(e) Comment on the likely effects of introducing corporation tax into the model you have employed in answering parts (a);

(f) If the market value of each of the companies at equilibrium is £325,000, calculate for both companies, firstly, the equilibrium price of an ordinary share, and, secondly, the WACC;

(g) Demonstrate that the approach that you used in part (a) fails to yield any benefit at the equilibrium position defined in part (f);