ABC company and XYZ company have identical assets and currently they both have a debtequity ratio of 1. Both companies have a cost of riskless debt of 4% and return on equity of 20%. Expected rate of return on market portfolio is 14% and firms are not subject to any taxes in this economy. a) ABC company decides to change its debt-equity ratio to 0.5 by issuing equity and retiring debt. What is its cost of equity after capital restructuring? b) XYZ company decides to change its debt-equity ratio to 2 by issuing debt and retiring equity. At this point, debt becomes risky and has a beta of 0.54, What is its cost of equity after capital restructuring? (Hint: You can use CAPM to estimate cost of risky debt)
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
ABC company and XYZ company have identical assets and currently they both have a debtequity ratio of 1. Both companies have a cost of riskless debt of 4% and
rate of return on market portfolio is 14% and firms are not subject to any taxes in this economy.
a) ABC company decides to change its debt-equity ratio to 0.5 by issuing equity and retiring debt. What
is its
b) XYZ company decides to change its debt-equity ratio to 2 by issuing debt and retiring equity. At this
point, debt becomes risky and has a beta of 0.54,
What is its cost of equity after capital restructuring? (Hint: You can use
debt)
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