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Sir, in this Qs Ziwa Co ungeared ke will be equal to Mlima Co Ke. This I have understood. But why they have used ke of Milma co while calculating value of Milma co. Why they have not calculated Milma co’s WACC and used the WACC?
The examiners answer explains the reason in the second paragraph of the required report:
Mlima Co cost of capital explanation
Ziwa Co’s ungeared cost of equity represents the return Ziwa Co’s shareholders would require if Ziwa Co was financed entirely by equity and had no debt. The return would compensate them for the business risk undertaken by the company.
This required rate of return would compensate Mlima Co’s shareholders as well because, since both companies are in the same industry, they face the same business risk. This rate is then used as Mlima Co’s cost of capital because of the assumption that Mlima Co will not issue any debt and faces no financial risk. Therefore its cost of equity (ungeared) is its cost of capital.
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