Company A 100 equity is valued at 15000000 and company B wh

Company A (100% equity) is valued at $15,000,000 and company B ( which has $3,000,000 in long term debt with an interest rate of 8%). Tax rate is 30%. Both A and B have identical after-tax profit $1,200,000 and it is given that both have identical operating risk profile and identical pretax income. Calculate;
a) Value of B
b) Capital structure mix of B
c) Cost of capital for A and B

Solution

a) Value of B (Levered Company) = Value of A (Unlevered Company) + Debt of B*Tax rate = 15000000+3000000*8% = $         1,52,40,000 b) Capital structure mix of A & B: Value of debt $             30,00,000 Value of equity (15240000-3000000) = $         1,22,40,000 Proportion of debt = 3000000/15240000 = 19.69% Proportioon of equity = 12240000/15240000 = 80.31% Proportion of debt and equity is 19.69%:80.31% c) Cost of capital for A = 1200000*(1-0.30)/15000000 = 5.60% Cost of capital for B: Cost of debt = 0.08*(1-0.30) = 5.60% Cost of equity = (1200000-3000000*8%)*(1-0.30)/12240000 = 5.49% WACC = 5.60*19.69%+5.49*80.31% = 5.51%