Kipling plc is a food manufacturer which has the following long-term capital structure:

£

£1 ordinary shares (fully paid)

Share premium account Retained profit 8% preference shares 10% debentures (secured)

2,500,000 1,000,000 1,400,000 1,200,000 2,600,000 8,700,000 The directors of the company wish to raise further long-term finance by the issue of either preference shares or debentures. One director, who supports the issue of debentures, believes that, although a debenture issue will increase the company’s gearing, it will reduce the overall cost of capital.

Required

(a) Discuss the arguments for and against the view that the company’s overall cost of capital can be reduced in this way. The views of Modigliani and Miller should be discussed in answering this part of the question.

(b) Discuss the major factors which the directors should consider when deciding between preference shares and debentures as a means of raising further long-term finance.

(c) Identify and discuss the major factors which will influence the amount of additional debenture finance that Kipling plc will be able to raise.
(ACCA Certified Diploma)