Corporate leaders usually find themselves at a cross-road regarding the decision on whether to engage in leverage to boost the firm value as this is a “double-edge sword” situation. More debt in the capital structure can raise the value of a firm and that same debt can reduce the value of a firm.

Explain the validity or otherwise of the above assertion and if possible anchor your discussion on the “Trade-off Theory” as postulated by Modigliani and Miller-1963.

In the course of your discussion, offer guidance on the existence or otherwise of an optimal capital structure as a way of alleviating the decision jargon that corporate leaders have to deal with. 

Alpha ltd is taking over Omega ltd. The shareholders of Omega ltd would receive 0.8 shares of Alpha ltd for each share held by them. The merger is not expected to yield any economies of scale and operating synergy. The relevant data for the two companies are as follows:

	Alpha	Omega
Net sales (ksh. Millions)	335	118
Profit after tax (ksh. Millions)	58	12
Number of shares	12,000,000	3,000,000
Market Value Per Share (ksh)	30	20

Required:

For the combined company (after merger), Calculate the;

1. Total Number of Shares,                                                                   
2. EPS,                                                                                                   
3. P/E ratio,                                                                                            
4. Market Value per share,                                                                    
5. Calculate the premium paid by Alpha ltd to the shareholders of Omega ltd.

Answer rating: 100% (QA)

REQUIREMENT 1 Tradeoff theory will be focusing upon the maintenance of an optimal capital structure that would be advocating that debt capital has tax ... View the full answer