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a company expect income of #1,000,000.It has #2,500,000, 8% debentures.The company equality capitalization rate of company...

a company expect income of #1,000,000.It has #2,500,000, 8% debentures.The company equality capitalization rate of company is 10%.calculate the value of firm and overall capitalization rate using net income approach (ignoring income tax)

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Answer #1

Net income = $1,000,000

Interest on 8% debentures = 8% of $2,500,000 = $200,000

Net income 1,000,000.00
less: interest on debentures 200,000.00
Earnings available to equity shareholders 800,000.00

Market value of equity = Earnings available to equity shareholders*100/equity capitalization rate

Thus market value of equity = 800,000*100/10

= $8,000,000

Market value of debentures = $2,500,000. Thus value of the firm = market value of equity+market value of debentures = 8,000,000+2,500,000

= $10,500,000 (value of the firm).

Overall capitalization rate = net income/value of the firm*100

= 1,000,000/10,500,000*100

= 9.52%

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