Q. Computation of Value of the Firm?

Illustration:-

EBIT                                                               = 50,000

10% Debentures                                              = 2, 00000

Overall Cost of Capital (K )                           = 12.5% o

Solution:-

(a) Computation of Value of the Firm:-

EBIT       = 50,000                  K_o = 12.5%

V = EBIT/ K_o =  50,000 / 12.5% = 50,000 / 12.5% X 100 = 4, 00,000

V = S + B        S = V-B           S = 4, 00,000 - 2, 00,000        = 2, 00,000

K_e =  50,000 -20,000 / 2, 00,000 X 100 = 15%

Calculation of Overall Cost of Capital:-

K_o = EBIT/ V X 100           K_o = 50,000/4, 00,000 X 100 = 12.5%

Value of the Firm = 4, 00,000                                    Overall Cost of Capital = 12.5%

(b) Computation of Value of the Firm (V) & Overall Cost of Capital When debt is raised to Rs, 3,00,000

EBIT = 50,000                                    K_o = 12.5%

V = 50,000/12,5% = 4, 00,000                                              Value of the firm = 4, 00,000

S = 4, 00,000- 3, 00,000 = 1, 00,000                                      Value of Equity = 1, 00,000

K_e = 50,000 -30,000 / 1, 00,000 -------- X 100 = 20%                                  Cost of Equity = 20%