Question
Smart Ltd has the following balance sheet structure: Assets Liabilities and Equity Assets $1000 Debt $300 Equity $700 Total $1000 $1000 Smart Ltds debtholders require
Smart Ltd has the following balance sheet structure:
Assets |
|
| Liabilities and Equity |
|
Assets | $1000 |
| Debt | $300 |
|
|
| Equity | $700 |
|
|
|
|
|
Total | $1000 |
|
| $1000 |
|
|
|
|
|
Smart Ltds debtholders require a return of 9% and shareholders require a return of 11%. Ignore tax rates.
Mr Very Smart, the CEO of Smart Ltd tells the Board of Smart Ltd that shareholders require a very high return, its cheaper to use debt to fund our projects. We should therefore raise debt and reduce our equity holdings. This will increase our returns.
Required:
1. Calculate the weighted average cost of capital for Smart Ltd.
2. Justify Mr Very Smarts advice to the Board of Smart Ltd.
please answer in 10minutes
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