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Market Value, Cost of Capital, and Total Income Available

The U Co. and the L Co. are identical in all aspects except that U Co. is all-equity financed while L Co. has $1,000 debt in 6% perpetual bonds outstanding (on which $60 of interest is paid each year). Both firms have expected net operating income of $300 (forever). Both firm distribute as dividends all income available to shareholders. There are no taxes. Assume no agency costs or bankruptcy costs. The cost of equity is 10% for the U Co. and 12% for the L co.

38. What is the market value of the L Co.?
A) $2,000
B) $1,000
C) $3,000
D) $6,000

39. What is the cost of capital for the L Co.?
A) 9%
B) 8%
C) 10%
D) 12%

40. What is the total income available annually to the U Co.'s security holders?
A) $300
B) $155
C) $65
D) $240

Solution Preview

The U Co. and the L Co. are identical in all aspects except that U Co. is all-equity financed while L Co. has $1,000 debt in 6% perpetual bonds outstanding (on which $60 of interest is paid each year). Both firms have expected net operating income ...

Solution Summary

This solution provides calculations for multiple choice questions regarding market value, cost of capital, and total income annually available.

$2.19