Question
Medium Pty Ltd and Average Pty Ltd are identical firms in every way except for capital structure (Average uses perpetual debt). The EBIT for both
Medium Pty Ltd and Average Pty Ltd are identical firms in every way except for capital structure (Average uses perpetual debt). The EBIT for both is expected to be $10 million forever. The shares of Medium are worth $100 million, and the shares of average are worth $50 million. The interest rate is 5 per cent and there are no taxes. Mrs A Bove owns $1 million of Averages shares. a. What rate of return is Mrs A Bove expecting? b. Show how Mrs A Bove could generate exactly the same cash flow and rate of return by investing in Medium and using home-made leverage. c. What is the cost of equity for Average? Compare your answer to your answer in part a. What do you notice? Explain. d. What is Mediums weighted average cost of capital? What is the weighted average cost of capital for Average Ltd? What principle does your answer illustrate
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started