Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

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

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      Leverage    Expected growth         Price  Dividend
      Company Sector  Ratio     of earnings/divs     per share  per share

           X     A     0                 0           £1     10p
           Y     A   0.5                 0           £2     30p
           T     B     0                 0           £2     30p
           U     B   0.2                 0           £2     35p

Where Leverage Ratio = Debt/(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.


(iii)Indicate how your advice might be modified if corporate taxes were introduced into the analysis.

Step by Step Solution

There are 3 Steps involved in it

Step: 1

i To calculate the cost of equity capital Ke for each company we can use the dividend discount model DDM Ke Dividend Price For Company X Ke 10p 1 010 ... blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Advanced Financial Accounting

Authors: Thomas Beechy, Umashanker Trivedi, Kenneth MacAulay

6th edition

013703038X, 978-0137030385

More Books

Students also viewed these Finance questions

Question

What is hedge accounting? Discuss.

Answered: 1 week ago

Question

1.10 Describe the medical model of abnormal behavior.

Answered: 1 week ago