i) Dependence Hypothesis:

b) The value of a company depends on its earning and the quality of its earnings. In case of a

proposition when where no taxes are there, then Apple has a greater value due to excessive

amount of free cash flows available to the company. The company has enough room to introduce

more debt into the company to reduce its taxes because it can raise debt at an extremely low rate.

This will save the 35% taxes on the company’s income which can be achieved by paying less

than 1% interest on its borrowing.

In case of proposition 2 where taxes are imposed into the company’s financial statements, in

such a case Microsoft is a better company due its better debt/equity makeup and the reason that

its earnings are not reliant on once source just like Apple’s earning which are reliant on Iphone

and Ipad.

Therefore the company must be better organized in order to achieve greater things and to

command a higher value from the investors.

Apple Debt to Equity = 12.5% or 0.125

Debt/Equity = 12.5/100

Total Capital = Debt + Equity

 = 112.5

i) 100 * x + 0.05*12.5/112.5 = 12

100x + 0.625 = 1350

100x = 1349

x = 13.49%

ii)((100 * x + 12.5(0.05)(0.65)))/(112.5) = 12

100x + 0.40625 = 12 * 112.5

100x = 1350 – 0.040625 = 13.49%