Assignment instructions:

The CFO of ABC plc is analysing the capital structure of the organisation. He claims that ABC is not financing itself in a way which reduces its cost of capital (WACC). The information below represents the ABCs financing as at 31 December 2016:

	000
Ordinary shares, 1 each	20000
Reserves	5000
7% preference shares, 1 each	10000
10% bonds (irredeemable 31 December 2016)	15000
Total capital	50000

Other information from stock market (as at 31December 2016): Ordinary share price (ex-div) 2.65

Preference share price (ex-div) 75p

Bond price for 10% bonds 107 per 100

Last 5 years dividends (most recent last) 21p, 23p, 25p 27p, 28pv

The CFO states that by issuing more debt ABC will lower its cost of capital. He suggests issuing 15m of 11 per cent bonds. These bonds will be sold at a 5%premium to their par value and will mature after 7 years. The money will be used to repurchase ordinary shares which ABC will further cancel. The CFO presumes that repurchasing will result in the organisations share price rise to 2.85 and the futuredividend growth rate to grow by 20%(relatively). He anticipates the price of the 10%bonds to be unaffected, but the price of the preference shares to drop to 68p. Corporate tax stands at 30%.

You are required to:

1) Calculate the book value and market value cost of capital (WACC) for ABC plc. (35marks)

2) Considering the proposed changes to ABCs capital structure, recalculate the organisations costof capital to reflect these changes and comment on the CFOs forecasts. (35marks)

3) Critically analyse whether you consider that organisations, by integrating a sensible level ofgearing into their capital structure, can decrease their WACC, ensuring the response integrates relevant empirical research within this area of study. (30 marks)