Bucco Tours Ltd and Storebay Tours Ltd operate in the same geographical area and are close competitors. They are simply mirror images of each other and their financial records reflect the same as well in terms of an identical EBIT of $160,000. However, the fundamental difference is just that while Bucco Tours is fully financed by equity, Storebay Tours follows a D/E ratio of 1. Both firms have assets worth $800,000 each and a share price of $25 each. The current market interest rate is 8% and both firms are enjoying a tax holidaybecause of the government policy to promote the tourism sector. Both Bucco Tours Ltd and Storebay Tours Ltd follow a 100% dividend payout policy. As a young graduate, you are aware that the economy will bounce back in the coming year and knowing that leverage magnifies gains in good times, you have decided to invest $50,000 in Storebay Tours Ltd. You are required to answer the following questions: a) What is the current cost of equity in Bucco Limited? b) What is your proportional ownership in Storebay Tours Ltd.? c) What is the total cash inflow and rate of return on your investment in Storebay Tours Ltd.? d) Using homemade leverage, demonstrate how an investor with 200 shares in Bucco Tours Ltd, the unlevered firm can enjoy the same payoff, i.e., total cash flows as that a shareholder with 200 shares enjoy in Storebay Tours Ltd.
Bucco Tours Ltd and Storebay Tours Ltd operate in the same geographical area and are close
competitors. They are simply mirror images of each other and their financial records reflect the
same as well in terms of an identical EBIT of $160,000. However, the fundamental difference
is just that while Bucco Tours is fully financed by equity, Storebay Tours follows a D/E
ratio of 1. Both firms have assets worth $800,000 each and a share price of $25 each. The
current market interest rate is 8% and both firms are enjoying a tax holidaybecause of the
government policy to promote the tourism sector.
Both Bucco Tours Ltd and Storebay Tours Ltd follow a 100% dividend payout policy.
As a young graduate, you are aware that the economy will bounce back in the coming year and
knowing that leverage magnifies gains in good times, you have decided to invest $50,000 in
Storebay Tours Ltd.
You are required to answer the following questions:
a) What is the current
b) What is your proportional ownership in Storebay Tours Ltd.?
c) What is the total
Ltd.?
d) Using homemade leverage, demonstrate how an investor with 200 shares in Bucco
Tours Ltd, the unlevered firm can enjoy the same payoff, i.e., total cash flows as that a
shareholder with 200 shares enjoy in Storebay Tours Ltd.
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 6 images
