Answer to Question #121472 in Finance for Sheshadri

Question #121472
Alpha Ltd is expecting annual earnings before interest and tax of ₹ 1.5 Lakhs. The company has 10% debentures of ₹ 4 lakhs and cost of Equity capital is 12%. Calculate the total value of the firm and the overall cost of capital of the firm according to Net Income Approach. Also comment what will happen to the value of the firm and the overall cost of capital if debt is increased in the capital structure.
1
Expert's answer
2020-06-11T10:56:24-0400

cost of capital:

EBIT=1.5

Less: Interest cost (10 %of 4)=0.4

Earnings (since tax is assumed to be absent)=1.1(1.5-0.4)

Shareholders’ Earnings=1.1Market value of Equity (1.1/12%)=9.17

Market value of Debt=4

Total Market value=13.17(4+9.17)

%


total value of the firm=13.17(4+9.17)


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