QUESTION 13

b) The optimal capital structure of DP Ltd. is as shown below.

Sources of capital

Weight

%

Long term debt

40

Preference share capital

10

Ordinary share capital

50

The company is contemplating selling $. 10 million worth of 20 - year 9% bonds with $.1,000 par value. The market price of the bond is currently $. 980. Assume a tax rate of 30%.

In addition, the company will issue 10% preference shares ($. 100 par value) that are expected to sell at $.87 each incurring $. 5 per share in floatation costs. Ordinary shares, currently priced at sh. Sh. 50 per share will also be issued Next year, the company expects to pay dividend of $. 4 per share. Past dividend patterns are as follows;-

Year

Dividend per share

2010

3.8

2009

3.62

2008

3.47

2007

3.33

2006

3.12

2005

2.97

A new issue of ordinary shares will attract $. 3 discount and a floatation cost of $. 2.5 per share.

The company has $ 300,000 in retained earnings and is considering investing in a project which will cost $. 1,200,000

Required:

i) The marginal cost of capital (MCC) assuming a 30% tax rate.

ii) Retained earnings break point.