Nolimits Ltd. is at the present time an all equity financed company with a cost of capital of

12.5%.

The manager, Ms Doverdecash (Ann to her friends), is considering whether it might

be desirable to issue some debt capital.

Debt is currently yielding 5% p.a. and may be

assumed to be risk free for all firms who issue it (or who wish to issue it).

To this end Ms

Doverdecash has collected data on four other companies, each of which falls into one of two

industrial sectors (A and B).

The data she has collected are summarised below:

Industrial

D-E

Expected growth

Price

Dividend

Company

Sector

Ratio

of earnings/divs

per share

per share

X

A

0

0

1

10p

Y

A

1:1

0

2

30p

T

B

0

0

2

30p

U

B

1:4

0

2

35p

Where D-E = debt equity.

There is no taxation.

(i)

Calculate the cost of Equity capital, the cost of Debt capital and the WACC for the

four companies.

(ii)

Given your answers to (i), advise Ms Doverdecash on the capital structure policy

which she should follow.

Explain and justify your answer by reference to relevant economic

theory.