Tekla Incorporated and Tongaat Limited are two identical firms except for their capital structure. Tekla Limited is an all equity company which is financed with N$600000 in ordinary shares. On the other hand, Tongaat Limited uses both equity and perpetual debt. Its ordinary shares are worth N$300 000 and interest rate on debt is 8%. Both companies expect earnings before interest and taxes (EBIT) of N$73 000. There are no taxes

Requirement

A) Suppose you own N$30 000 worth of Tongaat Limited’s ordinary shares, what rate of return would you be expecting?

b) Show how you could generate exactly the same cash flows and rate of return by investing in Tekla Incorporated and using home-made leverage.

C) Calculate the cost of equity for Tekla Incorporated and for Tonga at Limited and show the WACC for each company. What principle have you illustrated?