Question
Capital Structure The finance director of Netra plc, a company listed on the AIM (Alternative Investment Market), wishes to estimate what impact the introduction of
Capital Structure
The finance director of Netra plc, a company listed on the AIM (Alternative Investment Market), wishes to estimate what impact the introduction of debt |
|
finance is likely to have on the company's overall cost of capital. The | |
company is currently financed only by equity. | |
Netra plc Summarised capital structure | |
| 000 |
Ordinary shares (25 pence par value) | 500 |
Reserves | 1,100 |
| 1,600 |
The company's current share price is 420 pence, and up to 4 million of fixed |
|
rate irredeemable debt could be raised at an interest rate of 10% per annum. The corporate tax rate is 33%. |
|
Netra's current earnings before interest and tax are 2.5 million. These |
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earnings are not expected to change significantly for the foreseeable future |
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The company is considering raising either: |
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- 2 million in debt finance;
- 4 million in debt finance
In either case, the debt finance will be used to repurchase ordinary shares
Required:
- Using M&M's model in a world with corporate tax, estimate the impact on Netra's cost of capital raising:
- 2 million: and
- 4 million in debt finance
State clearly any assumptions that you make.
- Briefly discuss whether or not the estimates produced in part (a) are likely to be accurate.
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