Question
You received a call from the CEO of Able Group, one of your largest clients. He indicated that he is looking to invest in 1
You received a call from the CEO of Able Group, one of your largest clients. He indicated that he is looking to invest in 1 of 2 companies. Each company requires capital in the amount of $10 million and is expected to yield earnings of $1 million per year, all of which will be distributed annually. Company A requires 100% shareholder funding while Company B requires 50% shareholder funding as a creditor is willing to provide 50% of the capital required to operate the business.
The cost of equity capital for Company A and B is 9% and 10%, respectively. The interest rate for the debt capital offered by the creditor for Company B is 6%.
The CEO wanted your opinion as to whether the value of Company A and B would be impacted by the cost of the related capital and if so, which company would yield a higher valuation. Indicate how you would respond, explaining the rationale for your assertions.
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