CASE STUDY: 1

Qwert Typewriter Company and Yuiop Typewriters SAOG are identical except for capital structures. Qwert has 50 % debt and 50 % equity financing, whereas Yuiop has 20 % debt and 80 % equity financing. The borrowing rate for both companies is 13 % in a no-tax world and capital markets are assumed to be perfect. The earnings of both companies are not expected to grow, and all earnings are paid out to shareholders in the form of dividends. (5 Marks)

1. If you own 2 % of the common stock of Qwert, what is your OMR return if the company has net operating income of OMR 360,000 and the overall capitalization rate of the company, K_o is 18 %? What is the inferred equity capitalization rate, k_e?
2. Yuiop has the same net operating income as Qwert. What is the inferred equity capitalization rate of Yuiop? Why does it differ from that of Qwert?

CASE STUDY: 2

Enoch-Arden Corporation has earnings before interest and taxes of OMR 3 million and a 40% tax rate. It able to borrow at an interest rate of 14%, whereas its equity capitalization rate in the absence of borrowing is 18%. The earnings of the company are not expected to grow, and all earnings are paid out to shareholders in the form of dividends. In the presence of corporate but no personal taxes, what is the value of the company in an M&M world with no financial leverage? With OMR 4 million in debt? With OMR 7 million in debt? (5 Marks)

CASE STUDY: 3

Paramount Products SAOG wants to raise OMR 100 Million for diversification project. Current estimates of EBIT from the new project OMR 22 Million p.a. the cost of debt will be 15% for amounts up to and including OMR 40 Million, 16% for additional amounts up to and including OMR 50 Million and 18% for additional amounts above OMR 50 Million. The equity shares (face value of OMR 10) of the company have a current market value of OMR 40. This is expected to fall to OMR 32 if debts exceeding OMR 50 Million are raised. The following options are under consideration of the company.

Option	Debt	Equity
I	50 per cent	50 per cent
II	40 per cent	60 per cent
III	60 per cent	40 per cent

Determine EPS for each option and state which option should the Company adopt. Tax rate is 50%. (5 Marks)