Question No. 04

Particulate plc is an all-equity-financed business with a market value of 35 million and a cost of capital (after tax) of 20 per cent p.a. The business intends to purchase and cancel 8 million of equity finance using the cash raised from issuing 10 per cent irredeemable loan notes. The rate of corporation tax is 30 per cent. Assuming that the assumptions of Modigliani and Miller (in a world with taxes) are correct, how will the capital restructuring affect:

(a) The market value of Particulate plc;

(b) Its cost of equity; and

(c) Its weighted average cost of capital?