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.

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

iv) Cost of equity for both 15%

v) 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.'

c) Show how much an investor holding 1.0% in the overvalued firm can increase his returns without increasing risk.