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Question 2 Joyce Limited and Refiloe Limited are operating in the same industry. The companies have the same business risk and are almost identical in
Question 2 Joyce Limited and Refiloe Limited are operating in the same industry. The companies have the same business risk and are almost identical in all respects except for their capital structures and total market values. The companies' capital structures are summarized below: Joyce Limited M'000 20 000 Ordinary shares (25 cents par value) Share premium account 45 000 Profit and loss account 36 000 Shareholders' funds 101 000 The company's ordinary shares are trading at 140 cents Refiloe Limited M'000 Ordinary shares (M1 par value) 25 000 8 000 Share premium account Profit and loss account 44 000 Shareholders' funds 102 000 The company's ordinary shares are trading at 400 cents, and debentures at M100. The annual EBIT for both companies are M25m. Company income tax rate is 40% Required: (a). Calculate the WACC for each company (8marks), (3marks). (b). What is the expected value of Refiloe Limited? (c). If Joyce Limited was to borrow M20m, i. Calculate what effect this would have on the company's cost of capital according to Modigliani and Miller (MM) (10marks). ii. What implications would this suggest for the company choice of capital structure? (4marks). Question 2 Joyce Limited and Refiloe Limited are operating in the same industry. The companies have the same business risk and are almost identical in all respects except for their capital structures and total market values. The companies' capital structures are summarized below: Joyce Limited M'000 20 000 Ordinary shares (25 cents par value) Share premium account 45 000 Profit and loss account 36 000 Shareholders' funds 101 000 The company's ordinary shares are trading at 140 cents Refiloe Limited M'000 Ordinary shares (M1 par value) 25 000 8 000 Share premium account Profit and loss account 44 000 Shareholders' funds 102 000 The company's ordinary shares are trading at 400 cents, and debentures at M100. The annual EBIT for both companies are M25m. Company income tax rate is 40% Required: (a). Calculate the WACC for each company (8marks), (3marks). (b). What is the expected value of Refiloe Limited? (c). If Joyce Limited was to borrow M20m, i. Calculate what effect this would have on the company's cost of capital according to Modigliani and Miller (MM) (10marks). ii. What implications would this suggest for the company choice of capital structure? (4marks)
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