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Problem 2 The finance director of Netra plc, a company listed on the AIM (Alternative Investment Market) wishes to estimate what impact the introduction of debt finance is likely to have on the company overall cost of capital on the company's overall cost of capital. The company is currently is currently financed only by equity: Netra plc Summarised Capital Structure Ordinary shares (25 pence par value) Reserves $.000 500 1.100 1,600 The company's current share price is 420 pence, and up to $ 4 million of fixed rate five year debt could be raised at an interest rate of 10% per annum. The corporate tax rate is 33% Netra's current earnings before interest and tax are $ 2.5 million. These earnings are not expected to change significantly for the foreseeable future. The company is considering raising either: i. $ 2 million in debt finance or $ 4 million in debt finance ii. In either case the debt finance will be used to repurchase ordinary shares. Required a. using Miller and Modigliani's model in a world of corporate tax, estimate the impact on Netra's cost of capital of raising i. $ 2 million and ii. $ 4 million in debt finance. State clearly any assumptions that you make b. briefly discuss whether or not the estimate produced in part (a) are likely to be accurate Problem 3 Bacchante plc has a capital structure as follows: Bank loans Debenture loans Ordinary shares Cost of Capital Book Value % $m 9 5 12 8 15 18 Market Value $m 5 6 39 The company's current operations are carried from two locations. The Plot A factory shows a cash of $ 1,750,000 on capital employed of $ 27.5m., while the Plot B factory produces a cash surplus of $ 640,000 on its capital of $ 3.5m. It is proposed to invest a further $ 1.5m in facilities at Plot A factory which will increase cash flow by $ 150,000 to perpetuity. Required a. to calculate Bacchantes combined cost of capital b. to comment on the proposed expansion Problem 2 The finance director of Netra plc, a company listed on the AIM (Alternative Investment Market) wishes to estimate what impact the introduction of debt finance is likely to have on the company overall cost of capital on the company's overall cost of capital. The company is currently is currently financed only by equity: Netra plc Summarised Capital Structure Ordinary shares (25 pence par value) Reserves $.000 500 1.100 1,600 The company's current share price is 420 pence, and up to $ 4 million of fixed rate five year debt could be raised at an interest rate of 10% per annum. The corporate tax rate is 33% Netra's current earnings before interest and tax are $ 2.5 million. These earnings are not expected to change significantly for the foreseeable future. The company is considering raising either: i. $ 2 million in debt finance or $ 4 million in debt finance ii. In either case the debt finance will be used to repurchase ordinary shares. Required a. using Miller and Modigliani's model in a world of corporate tax, estimate the impact on Netra's cost of capital of raising i. $ 2 million and ii. $ 4 million in debt finance. State clearly any assumptions that you make b. briefly discuss whether or not the estimate produced in part (a) are likely to be accurate Problem 3 Bacchante plc has a capital structure as follows: Bank loans Debenture loans Ordinary shares Cost of Capital Book Value % $m 9 5 12 8 15 18 Market Value $m 5 6 39 The company's current operations are carried from two locations. The Plot A factory shows a cash of $ 1,750,000 on capital employed of $ 27.5m., while the Plot B factory produces a cash surplus of $ 640,000 on its capital of $ 3.5m. It is proposed to invest a further $ 1.5m in facilities at Plot A factory which will increase cash flow by $ 150,000 to perpetuity. Required a. to calculate Bacchantes combined cost of capital b. to comment on the proposed expansion