Hi there Just wondering, for part (vi) of the question, why is it that, when Company B's share price falls from $8,000,000 to $6,000,000, you are left with $300,000 to invest? I can understand that, mechanically, 6/8 x $400,000 is $300,000 but that's not my real question. I thought you always had $400,000 to invest under all circumstances. Does the solution imply that you initially invested in Company B and now you are selling out and switching to Company A? Thanks for any clarification.
The numbers here are changed to make the maths more simple (definitely not that we sell out of one and invest in another). If we had remained with £400k, and we had to stay with a debt to equity of 4:6 (which is what B's gearing now is!) we would have had £266.7k of borrowings, which is an awkward number. But if you compare the £400k invested in company B (gives about £45.3k of profit) with a £666.7k investment in A financed using 266.7K of debt (profit 66.7k, less interest 21.3k equals 45.4k profit) we end up at the same place - allowing for rounding. But with the numbers we have selected for this latter part, the maths becomes much neater.
Thanks Colin, that makes so much more sense. As an aside, would it also be correct to say that the equity value drops to £6,000,000 so that the asset values of both companies become the same (i.e. so that return on assets is equalised)?
