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Question 2 : Company A and Company B are identical except for capital structures. Company A has 90 percent debt and 10 percent equity financing,

Question 2: Company A and Company B are identical except for capital structures. Company A has 90 percent debt and 10 percent equity financing, whereas Company B is all equity financed with 8,000,000 capital structure. The borrowing rate of debt for both companies is 5 percent and capital markets are assumed to be perfect.

a. Company A has net operating income of $400,000 and the overall capitalization rate of the company, ko is 16 percent. If you own 10 percent of the common stock of Company A, what is the implied equity capitalization rate, ke and your net dollar return?

b. If Company B goes for financing with $4200000 debt. Find the value of levered firm of company B with tax shield benefit of 35% and bankruptcy cost of $500000?

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