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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

earnings are not expected to change significantly for the foreseeable future

The company is considering raising either:

  1. 2 million in debt finance;
  2. 4 million in debt finance

In either case, the debt finance will be used to repurchase ordinary shares

Required:

  1. Using M&M's model in a world with corporate tax, estimate the impact on Netra's cost of capital raising:
  1. 2 million: and
  2. 4 million in debt finance

State clearly any assumptions that you make.

  1. Briefly discuss whether or not the estimates produced in part (a) are likely to be accurate.

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