Company XCompany YRsRsNet operating income2000020000Cost of debt02500Net income2000017500Cost of equity0.080.10Market value of shares250000175000Market value of debt050000Total value of firm250000225000Cost of capital (Avg)0.950.08Debt equity ratio00.8Assumptions: 1) no corporate tax 2) equilibrium value is 12%.SolutionThe solution is explained below −Company XCompany YRsRsNet operating income2000020000(-)Cost of debt02500Net income2000017500Equilibrium cost of equity (12.5%)0.1250.125Value of firm160000140000Market value of debt050000Market value if equity16000090000

SolutionThe solution is given below −Company X is unlevered, which means, interest on debt is 0.Company y is levered, which means, interest on debt is 7000 (175000*4%)Market valueCompany XCompany YRsRsNet operating income4500045000Interest on debt070004500038000Profit before taxes4500038000Taxes (40%)18000152002700022800Capitalization rate (12%)0.120.12Market value equity225000190000Market value of debt0175000Total value225000365000

SolutionThe solution is as follows −Country 1: No taxesa) Debt to equity ratio is ZeroCost of equity = WACC + (WACC – Cost of debt) * (debt/equity)Cost of equity = 15% + (15% - 5%) * 0 => 10%b) Debt to equity ratio is 1Cost of equity = WACC + (WACC – Cost of debt) * (debt/equity)Cost of equity = 15% + (15% – 5%) * 1Cost of equity = 10% + 5% => 20%c) Debt to equity ratio is 2 Cost of equity = WACC + (WACC – Cost of debt) * (debt/equity)Cost of equity = 15% + (15% – ... Read More

SolutionThe solution is as follows −Cash bookBank statementDividend (Rs.2200/-)Balance (Rs.25000/-)Interest error(Rs.800/-)Uncashed check (Rs.2000/*)Deposited(Rs.3800/-)Uncredited (Rs.3500/-)Cash short(Rs.1200/*)Dues paid(Rs.1000/-)ABC Ltd BankReconciliation statementas on 30th September, XXXXBank overdraft (Dr)25000(+)Check issued (not enchased)2000Dividends on shares (collected by bank)2200Interest charged (recorded twice)800Check deposited (not entered in cash book)3800880033800(-)Cash short (credit side of bank column)1200Dues paid by bank1000Uncredited check (outstation)3500(5700)Balance (as per cash book) (Cr)28100

Company finances its assets by capital structure. It can finance its assets by either only equity or combination of debt and equity.Modigliani and miller proposed a theory in 1950s, which says, valuation of a company is irrelevant to its capital structure. It is also irrelevant, to whether company is highly leveraged or low debt because of its market value. It depends only on operating profits of company. This theory is also called as capital structure irrelevance principle.Modigliani and miller approach states the valuation of company is irrelevant to its capital structure. Let us say, Company X is financed by equity ... Read More

Trail balance of ABC Company as on 31st April XXXXDebit ($)Credit ($)Banking equipment10000DebtorsBank5000Capital16000Drawings600Loan1800CreditorsServices18000Salaries9500Telephone expenses7002580025800SolutionThe solution is as follows −While preparing income statement, we consider only expenses and income.Income => services => 18000Expenses => salaries + telephone expenses => 9500 + 700 => 10200Income statement for the company ABC for period ending on 31st April XXXXDebit ($)Credit ($)Income18000(services)18000Expenses(10200)Salaries95007800Telephone expenses700Net profit

Sales volumes of A (units)1500016500182001900020000Probability0.150.180.190.210.22Selling price per unit is Rs. 8/- with marginal cost = Rs. 4.80/- and fixed cost = Rs. 42000/-Calculate probability of company’sa) Break evenb) Makes profit of minimum Rs.20000/-SolutionThe solution is explained below −a) Break evenCalculated contribution costContribution cost= sales cost – marginal costContribution cost= 8 – 4.80Contribution cost= 3.20/-Breakeven point = fixed cost / contribution cost= 42000/3.20= 13125 units (app)Probability of sales more than or equal to 8077 unitsProbability of sales = (0.15+0.18+0.22+0.24+0.26) => 0.95 => 95%b) Makes profit of minimum Rs.20000/-Total contribution = (fixed cost) + profit => 42000 + 20000 => 62000 - ... Read More

In the annuity deprecation, method investment asset is considered as investment which yields fixed interest rate until the book value of asset becomes zero. Based on annuity table amount is calculated. This method is also known as compound interest method. This method is not approved by Generally Accepted Accounting Principles (GAAP). This method is suitable for assets, which require regular investments and need fewer changes.                    Annuity tableYear3%4%5%11.0301.0401.05020.5230.5300.53830.3540.3600.36740.2690.2750.28050.2180.2250.23160.1850.1910.19770.1600.1670.17380.1420.1480.15590.1280.1340.141100.1170.1230.130110.1080.1140.120120.1010.1070.113130.0940.1000.106140.0890.0950.101150.0840.0890.096Journal entryDateParticularsDrCrXX/XX/XXXXAsset accountTo bank account(Being asset is acquired)XXXXXXXXXXXX/XX/XXXXAsset accountTo Interest account(Being interest on capital sunk in asset )XXXXXXXXXXXX/XX/XXXXDepreciation accountTo asset account(Being the depreciation of asset ... Read More

SolutionThe solution is given below −Depreciable cost = 5000000 – 250000 => Rs.4750000/- Sinking fund value = [interest/ {(1+interst) ^period -1} => [0.1/{(1+0.1)^15-1} => 0.03147 Annual depreciation = depreciable cost * sinking fund factor => 4750000*0.03147 =>Rs. 149482.5/- Book value (year 1) => 5000000 – 149482.5 => Rs.4850517.45/- Interest earned (end of 2nd year) => 149482.5 * 0.1 => Rs.14948.25/- Increased fund (for 2nd year) => 149482.5+14948.25 => Rs.164430.75/- Accumulated Depreciation (end of 2nd year) => 149482.5+164430.75 => Rs.313913.25/- Book value (end of 2nd year) => (4850517.45 – 164430.75) => Rs.4686086.7/- Interest earned (at the end of 3rd year) => ... Read More

                    Journal entryDateParticularsDrCrXX/XX/XXXXDepreciation A/cTo sinking fund A/c(Being depreciation is transferred to sinking fund account)XXXXXXXX/XX/XXXXProfit and Loss A/cTo Depreciation A/c(Being depreciation is charged to profit and loss account)XXXXXXXX/XX/XXXXSinking fund investment A/cTo Bank A/c(Being amount of depreciation invested)XXXXXXXX/XX/XXXXBank A/cTo interest on sinking fund investment A/c(Being interest earned on sinking fund investment)XXXXXXXX/XX/XXXXBank A/cTo sinking fund investment A/c(Being sinking fund investment sold at the end of asset life)XXXXXXXX/XX/XXXXSinking fund investment A/cTo sinking fund A/c(Being profit on sale of investment transferred to sinking fund)XXXXXXXX/XX/XXXXSinking fund A/cTo sinking fund investment A/c(Being loss on sale of investment transferred ... Read More