Question 2 U Ltd. and L Ltd. are identical firms except that U Ltd. is ungeared while L. Ltd. Has R20million of 8% bonds

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Question 2 U Ltd And L Ltd Are Identical Firms Except That U Ltd Is Ungeared While L Ltd Has R20million Of 8 Bonds 1 (26.85 KiB) Viewed 41 times

Question 2 U Ltd. and L Ltd. are identical firms except that U Ltd. is ungeared while L. Ltd. Has R20million of 8% bonds outstanding. Both firms have a tax rate of 50%, earnings before interest and tax of R5million, and the cost of equity capital for U Ltd. is 10% p.a. Assume that all of the MM assumptions are met. Required: a) Estimate the market values of both U Ltd and L Ltd. (10) b) If the market value of U Ltd. equals R20million and the market value of L Ltd. equals R40million, are the companies over or under valued? How will investors react to these values? (15)