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Homework answers / question archive / Questions: 1
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.
