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?