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Business Valuation
After narrating the detail theory we will now see the net results on the companies which are working with fixed capital employed at different gearing levels.
Assumptions
- Capital employed will remain same for all companies.
- The gearing of the company can be changed immediately by issuing debt to repurchase the shares.
- There are no transaction costs for increase in debt.
- Upon valuation it is further assumed that Geared companies will remains geared at the same actual level of gearing in perpetuity.
- Business is identical with all relevant aspects and working in same circumstances. And return on capital employed, tax rates, interest rates will remain same.
- Net Profits of all companies are distributable to share holders; it means
Net Profits = Dividend = Re = Ra.
- Business risk is also constant, regardless of how the company invests its funds.
- Residual value of assets of the company is zero.
Illustration
- U is un-geared company and G1, G2, G3, G4 are companies which are Geared at different levels
- Capital employed of all the companies is fixed at all levels, which is US$ 50,000.
- Equity is decreasing with increase in Debt.
- ROCE, Interest Rate and Tax Rate are same for all companies.
Illustration: Un-Geared & Geared Companies
| Company Name |
|
U (US$) |
G1 (US$) |
G2 (US$) |
G3 (US$) |
G4 (US$) |
| Share Capital |
E ASSUMED |
50,000 |
40,000 |
35,000 |
30,000 |
25,000 |
| Loan |
D ASSUMED |
- |
10,000 |
15,000 |
20,000 |
25,000 |
| Total Capital Employed |
C (E+D) |
50,000 |
50,000 |
50,000 |
50,000 |
50,000 |
| ROCE |
R ASSUMED |
25% |
25% |
25% |
25% |
25% |
| Rate Of Interest |
Ri ASSUMED |
10% |
10% |
10% |
10% |
10% |
| Tax Rate |
Rt ASSUMED |
40% |
40% |
40% |
40% |
40% |
Income Statement: Un-Geared & Geared Companies
| |
|
U (US$) |
G1 (US$) |
G2 (US$) |
G3 (US$) |
G4 (US$) |
| Earning Before Interest & Tax |
EBIT CxR |
12,500 |
12,500 |
12,500 |
12,500 |
12,500 |
| Less Interest |
I DxRi |
- |
(1,000) |
(1,500) |
(2,000) |
(2,500) |
| Earning before Tax |
EBT (EBIT-I) |
12,500 |
11,500 |
11,000 |
10,500 |
10,000 |
| Tax @ 40% |
T (EBTxRt) |
(5,000) |
(4,600) |
(4,400) |
(4,200) |
(4,000) |
| Profit after Tax (Dividend) |
D (EBT-T) |
7,500 |
6,900 |
6,600 |
6,300 |
6,000 |
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