1) Consider two companies poncan and woncan are similar in all aspects accept for their capital structure

i) Poncan company 7.5%, shs.4 m debt

ii) Woncan company all equity financed.

Earnings before interest tax for the two companies is sh.900 m

Cost of equity for both 15%

Corporation tax rate 4%

Required:

a) Value of the five companies using Net/income approach. (6 marks)

b) Using MM's model, calculate the equilibrium value for the levered firm and Show how much an investor holding 1.0% in the overvalued firm can increase his returns without increasing risk. (7 marks)

b) A company proposes to invest in the divisible projects. A project can be accepted in the divisible or in whale. If accepted in part, both the cash flow and subsequent receipts are value pro-route. The five projects and their associated cash flows are as follows;

Year A B

0 10,000 20,000

1 20,000 10,000

2 30,000 ___

3 100,000 60,000

The cost of capital applicable for both is 10%. The cash flows occur in exactly 12 months intervals. No project can be deferred. The funds available are restricted as follows

Year funds available shs

1 20,000

2 25,000

3 20,000

Funds not utilized in one year will not be available in subsequent years.

Required;

a) Formulate a linear programming model to solve the above problem.

b) Solve the problem graphically.