The Bharat Company and The Charat Company belong to the same risk class-these com- panies are...

  

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The Bharat Company and The Charat Company belong to the same risk class-these com- panies are identical in all respects except that The Bharat Company has no debt in its capital structure, whereas The Charat Company employs debt in its capital structure. Relevant financial particulars of the two companies are given below. Bharat *500,000 Net Operating Income Debt Interest Equity Earnings Equity Capitalisation Rate Market Value of Equity Market Value of Debt (Debt Capitalisation Rate is 8%) Total Market Value of the Firm Average Cost of Capital 2500,000 12% 24,166,667 *4,166,667 12% Charat *500,000 *200,000 *300,000 14% *2,142,857 *2,500,000 34,642,857 10.77% (a) You own 10,000 worth of Bharat's equity. Show what arbitrage you would resort to. (b) When will, according to Modigliani and Miller, this arbitrage cease? The Bharat Company and The Charat Company belong to the same risk class-these com- panies are identical in all respects except that The Bharat Company has no debt in its capital structure, whereas The Charat Company employs debt in its capital structure. Relevant financial particulars of the two companies are given below. Bharat *500,000 Net Operating Income Debt Interest Equity Earnings Equity Capitalisation Rate Market Value of Equity Market Value of Debt (Debt Capitalisation Rate is 8%) Total Market Value of the Firm Average Cost of Capital 2500,000 12% 24,166,667 *4,166,667 12% Charat *500,000 *200,000 *300,000 14% *2,142,857 *2,500,000 34,642,857 10.77% (a) You own 10,000 worth of Bharat's equity. Show what arbitrage you would resort to. (b) When will, according to Modigliani and Miller, this arbitrage cease?