KK Ltd. and KT Ltd. are two companies in the printing industry. The companies have the same business risk and are almost identical in all respects for their capital structures and total market values.

KK Ltd. and KT Ltd. are two companies in the printing industry. The companies have the same business risk and are almost identical in all respects for their capital structures and total market values. The companies capital structures are summarised below:
KK Ltd. Sh.’000’ Ordinary shares (Sh.100 par value) 80,000 Share premium account 180,000 Profit and loss account 146,000 Shareholders’ funds 406,000 KK Ltd shares are trading at Sh.280
KT Ltd. Sh.’000’ Ordinary shares (Sh.200 per value) 100,000 Share premium account 32,000 Profit and loss account 176,000 Shareholders’ funds 308,000 12% debentures (newly issued) 100,000 408,000KT’s ordinary shares are trading at Sh.340 and debentures at Sh.200. Annual earnings before interest and tax for each company is Sh.100 million.Corporate tax is at the rate of 30%.Required:a) Values of the two firms (3 marks)b) If you owned 8% of the ordinary shares of KT Ltd. and you agreed with the arguments of Modigliani and Miller:i) Explain what action you would take to improve your financial position (2 marks)ii) Estimate by how much your financial position is expected to improve. Personal taxes may be ignored and assumptions made by Modigliani and Miller may be used. (5 marks)c) If KK Ltd. was to borrow Sh.80 million, compute and explain the effect this would have on the company’s cost of capital according to Modigliani and Miller. What implications would this suggest for the company’s choice of capital structure? (5 marks)
Question two

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