Question
** PLEASE HELP ME WITH PART E ONLY*** Burberry Group PLC is a British fashion clothing company. It is considering the replacement of one of
** PLEASE HELP ME WITH PART E ONLY***
Burberry Group PLC is a British fashion clothing company. It is considering the replacement of one of its existing machines with a new model. The existing machine can be sold now for 10,000. The new machine costs 60,000 and will generate free cash flows of 12,560 p.a. over the next 5 years. The corporate tax rate is 30%. The new machine has average risk. Burberrys debt-equity ratio is 0.4 and it plans to maintain a constant debt-equity ratio. Burberrys cost of debt is 6.30% and its cost of equity is 14.25%.
c) The average debt-to-value ratio in the fashion clothing industry is 20%. What would Burberrys cost of equity be if it took on the average amount of debt of its industry at a cost of debt of 5%? Do this calculation assuming the company does not pay taxes.
e) How could the capital structure change in question c) be explained based on what we know from the trade-off theory of capital structure? Assume the debt-to-value ratio of 20% is the new optimal capital structure for Burberry
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