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Questions: 1

Management

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Questions:

1.     Andrew Inc is presently financed entirely by equity shares. The current market value is $600000. A dividend of $120000 has just been paid. This level of dividends is expected to be paid indefinitely. The project would be financed by issuing $500000 debentures at the market rate of 18%. Ignoring tax consideration:

(i)             Calculate the value of equity shares and the gain made by the shareholders if the cost of equity rises to 21.6%.

(ii)            Prove that weighted average cost of capital is not affected by gearing.

2.     In considering the most desirable capital structure for a company, the following estimates of the cost of debt and equity capital (after tax) have been made at various levels of debt-equity mix:

Debt as a percentage of total capital employed	Cost of debt (%)	Cost of equity (%)
0	5.0	12.0
10	5.0	12.0
20	5.0	12.5
30	5.5	13.0
40	6.0	14.0
50	6.5	16.0
60	7.0	20.0

 You are required to determine the optimal capital structure for the company by calculating weighted average cost of capital.