Question 4 (25 marks) The CFO of Benedict Inc., a listed company, wants to assess the possible impact on the company's overall cost of capital (weighted average cost of capital - WACC) due to the introduction of debt financing. Currently, the company is an all-equity firm. Current capital structure Ordinary shares ($0.20 par value per share) $800,000 Reserves $1,200,000 Total $2,000,000 The company's current price is $2.1 per share and up to $4 million of fixed rate debt can be raised at an interest rate of 10% per annum. Benedict's current EBIT (earnings before interest and taxes) is $2.5 million. These earnings are expected to remain at a constant level for the foreseeable future. The company's tax rate is 33%. Two financing options are being considered by the company and the debt issue will be used to repurchase ordinary shares of the company: i $2 million debt issue or ii S4 million debt issue Required: a Applying Miller and Modigliani's model in a world with company tax, calculate the impact on Benedict's cost of capital (WACC) by stating any assumptions you make based on the debt issue of: i $2 million or ii S4 million What can you derive from (i) and (ii)? (17 marks) b Comment on whether or not your calculation in part (a) is likely to be (8 marks) correct. Question 4 (25 marks) The CFO of Benedict Inc., a listed company, wants to assess the possible impact on the company's overall cost of capital (weighted average cost of capital - WACC) due to the introduction of debt financing. Currently, the company is an all-equity firm. Current capital structure Ordinary shares ($0.20 par value per share) $800,000 Reserves $1,200,000 Total $2,000,000 The company's current price is $2.1 per share and up to $4 million of fixed rate debt can be raised at an interest rate of 10% per annum. Benedict's current EBIT (earnings before interest and taxes) is $2.5 million. These earnings are expected to remain at a constant level for the foreseeable future. The company's tax rate is 33%. Two financing options are being considered by the company and the debt issue will be used to repurchase ordinary shares of the company: i $2 million debt issue or ii S4 million debt issue Required: a Applying Miller and Modigliani's model in a world with company tax, calculate the impact on Benedict's cost of capital (WACC) by stating any assumptions you make based on the debt issue of: i $2 million or ii S4 million What can you derive from (i) and (ii)? (17 marks) b Comment on whether or not your calculation in part (a) is likely to be (8 marks) correct