PROBLEM 1: Two companies are identical in all respects except that X Ltd.has debt of Rs.

5,00,000 borrowed at the rate of

12% whereas Y Ltd.has no debt in its capital structure. The total assets of both the companies amount to Rs.15,00,0
on which the companies have earnings of 20%. You are required to do the following:
(i) Calculate value of companies and Ko using NI approach taking Ke as 18%.
(ii) Calculate value of companies and Ko using NOI approach taking Ke a ko as 18%
(iii) Compare the results and comment on the differences of two approaches.

SOLUTION TOTAL ASSETS 1500000

X LTD. DEBT 500000

(i) VALUE AS PER NI APPROACH

PARTICULARS X LTD.
EBIT 300000
LESS INTEREST 60000
PBT (EARNING AVAILABLE TO EQUITY SHAREHOLDERS) 240000
Ke 18%
MARKET VALUE OF EQUITY 1333333.33333333
MARKET VALUE OF DEBT 500000
VALUE OF THE FIRM 1833333.33333333
Ko 16.36%

(ii) VALUE AS PER NOI APPROACH

PARTICULARS X LTD.
EBIT 300000
LESS INTEREST 60000
PBT (EARNING AVAILABLE TO EQUITY SHAREHOLDERS) 240000
Ko 18%
MARKET VALUE OF FIRM 1666666.66666667
MARKET VALUE OF DEBT 500000
VALUE OF THE EQUITY 1166666.66666667
Ke 20.57%

X LTD
Source of capital Specific cost Book value
Equity Share Capital 20.57% 1,166,667
Debentures 12.00% 500,000
 1,666,667

WACC (Ko)

Y LTD
esc Ke=Ko=
deb
 VALUE OF THE FIRM
NI/NOI/MM APPROACH

00,000 borrowed at the rate of

he companies amount to Rs.15,00,000

RATE OF EARNINGS 20%

RATE OF INTEREST 12%
Ke 18%

Y LTD.
300000
0
300000
18%
1666666.66666667 E= NI/Ke
0
1666666.66666667
18.00% Ko=EBIT/V

Y LTD.
300000
0
300000
18%
1666666.66666667 E= EBIT/Ke
0
1666666.66666667
18.00% Ke= NI/E

Weighted cc
240000
60000
300000

18.00%
PROBLEM 2: Two companies are identical to each other except that S Ltd.has debt of Rs.4,00,000 at the rate of 8% whereas R
has no debt in its capital structure. The total assets of both the companies amount to Rs.25,00,000 on which compa
20%. Find the following if both thr companies are in tax bracket of 40%.
(i) Value and overall cost of capital of the companies using NI approach assuming Ke as 15%.
(ii) Value of the firm using NOI approach taking Ke of R Ltd.(Unlevered firm) as 15%.
(iii) Overall cost of capital of S Ltd. (Levered firm) using NOI/MM approach.

SOLUTION
TOTAL ASSETS 2500000 TAX 40%

EBIT RATE 20% Ke 15%

S LTD DEBT 400000 INTEREST 8%

(i) VALUATION AS PER NI APPROACH

S LTD. R LTD.
EBIT 500000 500000
LESS INTEREST 32000 0
PBT 468000 500000
LESS TAX 187200 200000
PAT or NI 280800 300000
COST OF EQUITY 15% 15%
VALUE OF EQUITY 1872000 2000000 E= NI/Ke
VALUE OF DEBT 400000 0
TOTAL VALUE OF FIRM 2272000 2000000 V= E+D

Ko 13.20% 15.00%

(ii) VALUE OF FIRM AS PER NOI APPROACH (MM APPROACH WITH TAXES)

VALUE OF UNLEVERED FIRM (R LTD.) 2000000

VALUE OF LEVERED FIRM (S LTD.) = Vu+Dt 2160000 VL= Vu+D*t

LESS VALUE OF DEBT 400000
VALUE OF EQUITY 1760000

Ke OF S LTD. =EARNINGS FOR EQUITY SHAREHOLDERS/ E 15.95%

Ko OF S LTD. 13.89%
he rate of 8% whereas R Ltd.
,00,000 on which company earns

S LTD.
Source of capital Specific cost Book value Weighted cc
Equity Share Capital 15.00% 1,872,000 280800
Debentures 4.80% 400,000 19200
2,272,000 300000

WACC (Ko) 13.20%

R LTD.
Ke=Ko= 15%

S LTD.
Source of capital Specific cost Book value Weighted cc
Equity Share Capital 15.95% 1,760,000 280800
VL= Vu+D*t Debentures 4.80% 400,000 19200
2,160,000 300000

WACC (Ko) 13.89%

R LTD.
Ke=Ko= 15%