QUESTION TWO Comment on the assertion that capital structure is strongly influenced by a) (6 marks) managerial behavior. The finance director of XYZ Ltd. Wishes to estimate what impact the b) introduction of debt finance is likely to have on the company's overall cost of company is currently financed by equity only. capital. The XYZ Ltd Summarized Capital Structure Sh. '000 Ordinary shares (Sh. 2.5 par value) 5,000 11,000 Reserves 16,000 The company's current share price is Shs. 4.20 and up to Sh. 4 million of fixed rate five- year debt could be raised at an interest rate of 10% per year. The corporate tax rate is 30%. XYZ Ltd.'s current earnings before interest and tax are Sh. 2.5 million. These earnings are not expected to change significantly for the foreseeable future. The company is considering raising either Sh. 2 million in debt finance or Sh. 4 million in debt finance. In either case the debt finance will be used to repurchase ordinary shares. Required:- Using Modigliani and Miller's model in a world with corporate tax, estimate the impact on XYZ Ltd's weighted average cost of capital of raising:- i) Sh. 2 million in debt finance (7 marks) Sh. 4 million in debt finance ii) (7 marks) Comment on the accuracy of the estimates produced in (b) (i) and (ii) above. c) (5 marks) QUESTION TWO Comment on the assertion that capital structure is strongly influenced by a) (6 marks) managerial behavior. The finance director of XYZ Ltd. Wishes to estimate what impact the b) introduction of debt finance is likely to have on the company's overall cost of company is currently financed by equity only. capital. The XYZ Ltd Summarized Capital Structure Sh. '000 Ordinary shares (Sh. 2.5 par value) 5,000 11,000 Reserves 16,000 The company's current share price is Shs. 4.20 and up to Sh. 4 million of fixed rate five- year debt could be raised at an interest rate of 10% per year. The corporate tax rate is 30%. XYZ Ltd.'s current earnings before interest and tax are Sh. 2.5 million. These earnings are not expected to change significantly for the foreseeable future. The company is considering raising either Sh. 2 million in debt finance or Sh. 4 million in debt finance. In either case the debt finance will be used to repurchase ordinary shares. Required:- Using Modigliani and Miller's model in a world with corporate tax, estimate the impact on XYZ Ltd's weighted average cost of capital of raising:- i) Sh. 2 million in debt finance (7 marks) Sh. 4 million in debt finance ii) (7 marks) Comment on the accuracy of the estimates produced in (b) (i) and (ii) above. c)