Question 2

Crystal Ltd has a capital structure of:

Ordinary share 500 000 @ $1.00 $ 500 000

10% debentures 800 000

8% preference shares 200 000

Retained earnings 100 000

7% mortgage 100 000

Additional information:

Ordinary shares $1.30

Preference shares $1.10

Debentures $103.00

The company's expected dividend on ordinary shares is 10 cents per share and is expected to

grow by 5% p.a. Debentures will mature in 4 years' time at face value. The company tax rate is

30% p.a. Mortgage finance will be available at the current rate of 7%.

Required:

a) Calculate the cost of each source of finance and the weighted average cost of capital.

b) Crystal Ltd has decided to invest in a project that will cost $1 million dollars and is undecided

whether to issue shares of $1.00 or to issue dentures at 12%. Using the information supplied

above, determine whether they should use shares or debentures to raise the necessary funds.

i) Calculate the indifference point and determine the EPS at that point.

ii What would be your recommendation if EBIT was expected to be only $275 000?

iii) What is the degree of financial leverage at the indifference point and at $275 000?