Q1. (a) Two companies, Alpha and Beta, exist in a Modigliani and Miller (1958, 1963) world. The companies each make identical, consistent annual net operating income of $3,600,000; and are otherwise identical except that company Alpha is all-equity funded, and company Beta is partly funded by $5m (nominal value) 4% debt. The cost of equity of an all equity financed firm is 12%, the pre-tax market cost of debt is 2%, and the rate of corporation tax is 25%. [10 marks] For each of the companies, calculate: its total market value; the market value of its equity; its cost of equity; and its weighted average cost of capital (b) Assume now that Alpha and Beta exist in a Miller (1977) world, that the rates of tax on income for debt providers and equity investors are 20% and 30%, respectively, and that the parameters given in part (a) are otherwise the same. Recalculate the total market value of each company. [6 marks] (c) Assume now that Alpha and Beta exist in a Modigliani and Miller world adjusted to allow for partial payout and investor-level taxes on both income and gains. An imputation tax system operates in this world, with the imputed tax credit on income to equity investors being 10%. The rate of tax on gains to equity investors is 40%. Alpha and Beta each distribute 60% of their after- tax earnings. The parameters given in parts (a) and (b) are otherwise the same. Recalculate the total market value of each company. [6 marks] (d) Discuss and critically evaluate the following statement: Modigliani and Miller have proved that corporation tax is advantageous to the value of levered firms. [10 marks] (e) Gamma operates in an M&M (1958, 1963) world adjusted to allow for different risk classes to exist. The company has a leveraged equity beta Bu of 1.6, and 60% risk-free debt in its capital structure. The pre-tax cost of debt is 3% and the expected return on the market is 14%. The company is considering investment in a new project that is expected to yield an after-tax internal rate of return of only 10%. Another company whose business is similar to the new project being considered has a leveraged equity beta B. of 0.9, and 20% debt in its capital structure. The rate of corporation tax faced by both companies is 30%. If Gamma would finance the new project 40% by way of debt, should it be accepted ? [8 marks] [Total: 40 marks] Q1. (a) Two companies, Alpha and Beta, exist in a Modigliani and Miller (1958, 1963) world. The companies each make identical, consistent annual net operating income of $3,600,000; and are otherwise identical except that company Alpha is all-equity funded, and company Beta is partly funded by $5m (nominal value) 4% debt. The cost of equity of an all equity financed firm is 12%, the pre-tax market cost of debt is 2%, and the rate of corporation tax is 25%. For each of the companies, calculate: its total market value; the market value of its equity; its cost of equity; and its weighted average cost of capital [10 marks] (b) Assume now that Alpha and Beta exist in a Miller (1977) world; that the rates of tax on income for debt providers and equity investors are 20% and 30%, respectively; and that the parameters given in part (a) are otherwise the same. Recalculate the total market value of each company. [6 marks] (c) Assume now that Alpha and Beta exist in a Modigliani and Miller world adjusted to allow for partial payout and investor-level taxes on both income and gains. An imputation tax system operates in this world, with the imputed tax credit on income to equity investors being 10%. The rate of tax on gains to equity investors is 40%. Alpha and Beta each distribute 60% of their after- tax earnings. The parameters given in parts (a) and (b) are otherwise the same. Recalculate the total market value of each company. [6 marks] (d) Discuss and critically evaluate the following statement: Modigliani and Miller have proved that corporation tax is advantageous to the value of levered firms. [10 marks] (e) Gamma operates in an M&M (1958, 1963) world adjusted to allow for different risk classes to exist. The company has a leveraged equity beta Bl of 1.6, and 60% risk-free debt in its capital structure. The pre-tax cost of debt is 3% and the expected return on the market is 14%. The company is considering investment in a new project that is expected to yield an after-tax internal rate of return of only 10%. Another company whose business is similar to the new project being considered has a leveraged equity beta BL of 0.9, and 20% debt in its capital structure. The rate of corporation tax faced by both companies is 30%. If Gamma would finance the new project 40% by way of debt, should it be accepted ? [8 marks] [Total: 40 marks] Q1. (a) Two companies, Alpha and Beta, exist in a Modigliani and Miller (1958, 1963) world. The companies each make identical, consistent annual net operating income of $3,600,000; and are otherwise identical except that company Alpha is all-equity funded, and company Beta is partly funded by $5m (nominal value) 4% debt. The cost of equity of an all equity financed firm is 12%, the pre-tax market cost of debt is 2%, and the rate of corporation tax is 25%. [10 marks] For each of the companies, calculate: its total market value; the market value of its equity; its cost of equity; and its weighted average cost of capital (b) Assume now that Alpha and Beta exist in a Miller (1977) world, that the rates of tax on income for debt providers and equity investors are 20% and 30%, respectively, and that the parameters given in part (a) are otherwise the same. Recalculate the total market value of each company. [6 marks] (c) Assume now that Alpha and Beta exist in a Modigliani and Miller world adjusted to allow for partial payout and investor-level taxes on both income and gains. An imputation tax system operates in this world, with the imputed tax credit on income to equity investors being 10%. The rate of tax on gains to equity investors is 40%. Alpha and Beta each distribute 60% of their after- tax earnings. The parameters given in parts (a) and (b) are otherwise the same. Recalculate the total market value of each company. [6 marks] (d) Discuss and critically evaluate the following statement: Modigliani and Miller have proved that corporation tax is advantageous to the value of levered firms. [10 marks] (e) Gamma operates in an M&M (1958, 1963) world adjusted to allow for different risk classes to exist. The company has a leveraged equity beta Bu of 1.6, and 60% risk-free debt in its capital structure. The pre-tax cost of debt is 3% and the expected return on the market is 14%. The company is considering investment in a new project that is expected to yield an after-tax internal rate of return of only 10%. Another company whose business is similar to the new project being considered has a leveraged equity beta B. of 0.9, and 20% debt in its capital structure. The rate of corporation tax faced by both companies is 30%. If Gamma would finance the new project 40% by way of debt, should it be accepted ? [8 marks] [Total: 40 marks] Q1. (a) Two companies, Alpha and Beta, exist in a Modigliani and Miller (1958, 1963) world. The companies each make identical, consistent annual net operating income of $3,600,000; and are otherwise identical except that company Alpha is all-equity funded, and company Beta is partly funded by $5m (nominal value) 4% debt. The cost of equity of an all equity financed firm is 12%, the pre-tax market cost of debt is 2%, and the rate of corporation tax is 25%. For each of the companies, calculate: its total market value; the market value of its equity; its cost of equity; and its weighted average cost of capital [10 marks] (b) Assume now that Alpha and Beta exist in a Miller (1977) world; that the rates of tax on income for debt providers and equity investors are 20% and 30%, respectively; and that the parameters given in part (a) are otherwise the same. Recalculate the total market value of each company. [6 marks] (c) Assume now that Alpha and Beta exist in a Modigliani and Miller world adjusted to allow for partial payout and investor-level taxes on both income and gains. An imputation tax system operates in this world, with the imputed tax credit on income to equity investors being 10%. The rate of tax on gains to equity investors is 40%. Alpha and Beta each distribute 60% of their after- tax earnings. The parameters given in parts (a) and (b) are otherwise the same. Recalculate the total market value of each company. [6 marks] (d) Discuss and critically evaluate the following statement: Modigliani and Miller have proved that corporation tax is advantageous to the value of levered firms. [10 marks] (e) Gamma operates in an M&M (1958, 1963) world adjusted to allow for different risk classes to exist. The company has a leveraged equity beta Bl of 1.6, and 60% risk-free debt in its capital structure. The pre-tax cost of debt is 3% and the expected return on the market is 14%. The company is considering investment in a new project that is expected to yield an after-tax internal rate of return of only 10%. Another company whose business is similar to the new project being considered has a leveraged equity beta BL of 0.9, and 20% debt in its capital structure. The rate of corporation tax faced by both companies is 30%. If Gamma would finance the new project 40% by way of debt, should it be accepted ? [8 marks] [Total: 40 marks]