Question 4

Fitness Training (FST) is a HK-based plc which produces gym equipment. Their business has grown quite quickly over the past few years and, as with most young companies in heavily capitalised industries, their only concern was if they had sufficient cash to continue to develop their operations. With stability and liquidity now being less of a concern the CEO of FST, is currently reviewing the companys capital structure to gauge if they are structured in an appropriate way. By her own admission, she does not have much knowledge in this area and has asked for your help as an expert in the field of corporate financial management.

She has given you the following information:

Number of Ordinary shares in issue: 20,000,000

Market Price per Ordinary share 240 cents

Value of Current long-term debt HK$30,000,000

Gross Interest rate on long-term debt 5% p.a.

Estimation of cost of equity 11% p.a.

Tax rate 20%

Required:

1. Calculate FSTs current after tax weighted average cost of capital.

(6 marks)

The CEO is keen to take on more debt as he has heard that debt is always cheaper than equity.

2. Using the information above evaluate this comment from both a practical and theoretical basis.