Please help me with another question - Modigliani and Miller

S

srahman33

New member
Joined
Jun 18, 2026
Messages
0
Reaction score
0
Hi I was wondering if somebody could be so kind as to help me with another question I have.
Marble plc and Brick plc are two companies that operate in the same line of business. Both companies distribute all their earnings as dividends.
Brick plc is financed by 8 million ordinary shares with a market value of 500p each and by £40 million 5% irredeemable debentures with a market value of £55 each. Brick plc has operating earnings before interest and tax of £16 million per annum.

Marble plc is financed by 30 million ordinary shares with a market value of 450p each and by £75 million 10% irredeemable debentures with a current market value of £110 each. Marble plc has operating earnings before interest and tax of £55 million per annum.

The rate of corporation tax is given as 30%.

(i) Calculate the after tax cost of equity, the cost of debt, and the overall weighted average cost of capital for both Slate plc and Tile plc.

(ii) Mr Leak holds 1,000 shares in Marble plc. Carefully and fully explain showing all calculations what actions Mr Leak would have to take if he wished to switch his investment from Marble plc to Brick plc but still retain the same level of risk. Would you advise Mr Leak to go ahead with such a switch?

(iii) Calculate Mr Leak’s original income in Marble plc and his new income in Brick plc if he switches his investment in the way you have advised in part (ii). What does this tell us about his new investment?
Thank yo so much in advance!
 
brick
8m * 5 = 40m
40m * 0.55 = 22m
interest = 40m * 0.05 = 2m
EBT = 16m - 2m = 14m
NI = 14m * (1-0.3) = 9.8m
EPS = 9.8m/8m = 1.225
Cost of equity = 1.225/5 = 24.5%
Cost of debt = 5/55 = 9.09%
WACC = (40/62 * 0.234) + 22/62 * 9.09 * (1-0.3) hey there is nothing tough about these questions.. you need to start doing these for yourself..
 
I think there are two flaws in you calculation:
1. The yield on the debt is (40”GBP x 5%)/(55”GBP) = 3.64%. This results in an after tax costs of debt of 3.64% x (1-0.3) = 2.55%
2. IMHO your debt and equity weights are wrong as well: The market value of debt is 55”GBP instead of 22”GBP taken by you. This results in weights for equity of 42% and for debt of 58%.
So please think before you blame others…
 
onlysimon wrote:
brick
8m * 5 = 40m
40m * 0.55 = 22m
interest = 40m * 0.05 = 2m
EBT = 16m - 2m = 14m
NI = 14m * (1-0.3) = 9.8m
EPS = 9.8m/8m = 1.225
Cost of equity = 1.225/5 = 24.5%
Cost of debt = 5/55 = 9.09%
WACC = (40/62 * 0.234) + 22/62 * 9.09 * (1-0.3) hey there is nothing tough about these questions.. you need to start doing these for yourself..
Click to expand...
Thank you again!
Well I actually did the first part, although I got a different cost of debt to you.
However it’s part 2 mainly that I am stuck with. I completed part 2, but I am really not sure if it is correct.
The way I did it was I have the scale factor difference of the companies by dividing the EBIT in the present company by the new company, multiplied by the equity in the new company, multiplied by the proportion held in the present company. Is that correct?
But then the problem that occurs is that after the switch, risk must be the same, therefore income must remain constant, but only based on my calculations there is a discrepency in the income.
That’s what I am mainly stuck on.
 
“£40 million 5% irredeemable debentures with a market value of £55 each.”
Sorry, but this means the market value is 40m * 55/100 = 22mio. I don’t know how else the sentence could be interpreted.
for (ii) the question is badly formed. There is no stated risk in either investment.
 
..and of course yield for a perpetual is simply the coupon divided by the price = 5/55.
 
You must log in or register to reply here.
Back
Top