QUESTION 1 CAPITAL STRUCTURE

Bula Textiles has an ordinary-share capital structure.

The selected financial data for the company are shown below:

Ordinary shares outstanding = 2,000,000

Ordinary share price= $10 per share

Expected level of EBIT = $5,000,000

Dividend payout ratio = 100%

In answering the following questions, assume that company income is not taxed.

Required:

a) Under the present capital structure, what is the total value of the company?

b) What is the cost of ordinary share capital?

c) Suppose that Bula Textile sells $1 million of long-term debt with an interest rate of 8%. The proceeds are used to retire the ordinary shares. What will be the companys cost of ordinary equity after the capital structure change?

(i) What will be the dividend per share flowing to the companys ordinary shareholders?

(ii) By what percentage has the dividend per share changed as a result of the capital-structure change?

(iii) By what percentage has the cost of ordinary equity changed as a result of the capital- structure change?

(iv) What will be the cost of capital after the capital-structure change? Please show your calculation