Compute value of firms x and y using the net income approach

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Question: Company X and Company Y are in the same risk class, and are identical in every fashion except that Company X uses debt while Company Y does not. The levered firm has Shs 900,000 debentures, carrying 10% rate of interest. Both the firms earn 20% before interest and taxes on their total assets of Shs 1,500,000. Assume perfect capital markets, rational investors and so on; a tax rate of 50% and Capitalisation rate of 15% for an all equity company.

(i) Compute the value of firms X and Y using the net income (NI) approach.

(ii) Compute the value of each firm using the net operating income (NOI) approach.

(iii) Using the NOI approach, calculate the overall cost of capital (ko) for firms X and Y.

(iv) Which of these two firms has an optimal capital structure according to the NOI approach? Why?

Reference no: EM133331526

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