Manny Co is a listed company that plans to spend $10m on expanding its existing business. It has been suggested that the money could be raised by issuing 9% loan notes redeemable in ten years time. Current financial information on Manny Co is as follows.

Income statement information for the last year

$000

Profit before interest and tax 7,000

Interest (500)

Profit before tax 6,500

Tax (1,950)

Profit for the period 4,550

Balance sheet for the last year $000 $000

Non-current assets 20,000

Current assets 20,000

Total assets 40,000

Equity and liabilities

Ordinary shares, par value &1 5,000

Retained earnings 22,500

Total equity 27,500

10% loan notes 5,000

9% preference shares, par value $1 2,500

Total non-current liabilities 7,500

Current liabilities 5,000

Total equity and liabilities 40,000

The current ex div ordinary share price is $4.50 per share. An ordinary dividend of 35 cents per share has just been paid and dividends are expected to increase by 4% per year for the foreseeable future. The current ex div preference share price is 76.2 cents. The loan notes are secured on the existing non-current assets of Manny Co and are redeemable at par in eight years time. They have a current ex interest market price of $105 per $100 loan note. Manny Co pays tax on profits at an annual rate of 30%.

The expansion of business is expected to increase profit before interest and tax by 12% in the first year. Manny Co has no overdraft.

Average sector ratios:

Financial gearing: 45% (prior charge capital divided by equity capital on a book value basis)

Interest coverage ratio: 12 times

Required:

(a) Calculate the current weighted average cost of capital of Manny Co.

(b) Discuss whether financial management theory suggests that Manny Co can reduce its weighted average cost of capital to a minimum level.

(c) Evaluate and comment on the effects, after one year, of the loan note issue and the expansion of business on the following ratios:

(i) Interest coverage ratio;

(ii) Financial gearing;

(iii) Earnings per share.

Assume that the dividend growth rate of 4% is unchanged.