Robs Rockery Ltd, a nightclub and pub operator, is considering different capital structures for its future. While the company had rapid growth in the past, its growth has been converging to a near constant rate. The company has been listed for many years and can be considered a mature business facing limited risk; however, in the eyes of the management of the company, the capital structure does not reflect this as very little debt is employed in the structure. A recent shareholder meeting led to a call for more debt to be used, higher earnings per share to be achieved and, in turn, increased dividend payments to be made, while a push for higher return on equity (ROE) was also requested by many shareholders. A dividend pay-out ratio of 30% had been agreed to in principle, dependant on the viability thereof under a capital structure incorporating more debt. Other relevant current information is provided in the table below:

Current item	Current value
Beta:	1.2
D/E (debt/ equity) ratio	50%`
Market cost of debt	10% (relevant to Robs Rockery Ltd)
Risk-free rate	5%
Market return	10%
Market risk premium	5%
Shares in issue	500,000
Market price per share	R10
Total liabilities	R2,000,000
Total assets	R6,000,000
Stable dividend	R1
Operating profit (EBIT)	R3,000,000 (not expected to change under either new structure)
Book cost of debt	3% (applicable to total liabilities under the current capital structure)
Tax rate	28%

The two proposed structures that the company are considering is as follows:

Structure X: 50% debt, 50% equity

Structure Y: 60% debt, 40% equity

The book weights of the different sources of capital are considered to approximate the market weights in the cases of both possible structures, and the company has no target capital structure it intends to revert to in the future. The group chief financial officer (CFO) of the holding company of which Robs Rockery Ltd is a subsidiary, found that the company can best borrow from a bank at a market related cost of 10% on new loans while it would be possible to issue shares at R10 apiece and net 90% of the issue price. The board has resolved that no shares will be bought back or retired and that retained earnings should not be touched during this exercise.

Required:

The group CFO has tasked you, the financial manager of Robs Rockery Ltd, with tabling different sources of financing the company can use. She has already proposed proportions of capital based on her extensive experience in the field and industry. She has tasked you with evaluating the two options that will go to the board. Both capital structures are considered to be plausible and have benefits and drawbacks; therefore, the group CFO tasked you with evaluating the two possible structures as set out below: The report should be structured as follows (with the expected calculations to base your discussions on indicated in brackets):

A. Cost (weighted average cost of capital)

B. Risk (debt ratio, times interest earned or interest coverage ratio)

C. Profitability (ROE, EPS)

D. Dividend payment feasibility (dividends per share)

E. Financial flexibility of each structure

F. Arguments for and against each structure