Two Fijian firms, Nirvana Ltd and Octopusweb Ltd, are identical, in all respects, except that Nirvana is debt-free and Octopusweb has a capital structure that is 40% debt and 60% equity, by market value. Suppose that each firm will have a net operating income (EBIT) of $1m. The required return on assets, r, is 10% and the yield to maturity, rd, is 6%.

REQUIRED

a. Find the market value of the two firms?

b. What are the two companies' ROE?

c. Comment on the required rates of return calculated in part b.

d. Suppose that Octopusweb Ltd has to pay a corporate tax of 20%, how much will its market value change?

e. Comment on your answer in part d above.