Usk Plc and Gant Plc are both public companies, whose shares are quoted on the Stock Exchange. Both earn an annual net operating income, before charging debenture interest, of £4 million, and it is generally expected that they will continue to do so indefinitely. The net operating income of both companies, before charging debenture interest, is subject to an identical degree of business risk. Usk is financed with 100% equity. Gant is financed with 50% debt and 50% equity. Assume both Usk and Gant operate in Modigliani and Miller’s(M&M) world. Required: (a)What are your expectations for the total market value of the two companies and for their weighted average cost of capital? Hint: Do not forget that they operate in M&M world (b) Briefly discuss how the imposition of tax and bankruptcy costs affects M&M theory of capital structure.
Usk Plc and Gant Plc are both public companies, whose shares are quoted on the Stock Exchange. Both earn an annual net operating income, before charging debenture interest, of £4 million, and it is generally expected that they will continue to do so indefinitely. The net operating income of both companies, before charging debenture interest, is subject to an identical degree of business risk.
Usk is financed with 100% equity.
Gant is financed with 50% debt and 50% equity.
Assume both Usk and Gant operate in Modigliani and Miller’s(M&M) world.
Required:
(a)What are your expectations for the total market value of the two companies and for their weighted average cost of capital?
Hint: Do not forget that they operate in M&M world
(b) Briefly discuss how the imposition of tax and bankruptcy costs affects M&M theory of capital structure.
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