Consider two (zero-growth) companies identical in every respect except that Company ABC has no financial leverage, whereas Company XYZ has $450,000 of 10 percent bonds outstanding. According to the traditional approach to capital structure, Company XYZ may have a higher total value and lower weighted average cost of capital than Company ABC. For simplicity, assume that Company XYZ’s debt has a market value equal to its par value (implying that the coupon rate on its debt equals the current market-required interest rate). We also assume that the required return on equity for Company XYZ is 17 percent (slightly higher than that of Company ABC). Income tax rates for both companies are assumed to be same at 35 percent. Calculate valuation of both companies. Assume any amount of earnings before interest and tax for both companies. Also calculate valuation process of both companies if Company XYZ has no financial leverage and Company ABC has 12 percent bonds at $400,000.

Answer rating: 100% (QA)

Ass ume any amount of earnings before interest and tax for both companies ANS WER ... View the full answer