Theories of Capital Structure
Assignment: Capital Structure
PART A 1. Apple Corporation has 2.5 million shares outstanding with a market value of $2.00 each (expected return = 16%) and debt with a market value of $1, 000,000 and a return of 10%
Required
a. What is the return on the capital of Apple Corporation? [Show all workings and formulae) [7.5 marks]
2. Samsung generates pre-tax earnings of $2,000,000 per year. Currently it has issued 1 million shares which sell for $10 each. Samsung has no debt in its capital structure. It is proposing a deal, which will allow it to borrow $5 million at 8% and buy back 500,000 shares and cancel them.
Required
a. What will be the share price after the deal? b. What is the weighted average cost of capital before and after the deal? [15 marks]
3. Nokia is all equity financed (that is it has no debt). Its shares have a return of 10%.
Du is the same as Etisalat. It is predicting cash flows before tax and interest of $3 million a year for ever. The management of Du are trying to decide on their financing arrangements and face three scenarios: * Scenario 1: Borrow no money * Scenario 2: Borrow $5 million at an interest rate of 6% with the balance coming from equity. * Scenario 3: Borrow $10 million at an interest rate of 8% with the balance coming from equity.
In all three cases Du will have 1 million shares.
Required
c. What will the share price under each scenario? [7.5 marks]
d. What is the weighted average cost of capital? [10 marks]
e. Discuss the advantages and disadvantages that may accrue to a firm and its shareholders, of the firm finances its projects using debt. [25 marks]
PART B 1. Discuss the
PART A 1. Apple Corporation has 2.5 million shares outstanding with a market value of $2.00 each (expected return = 16%) and debt with a market value of $1, 000,000 and a return of 10%
Required
a. What is the return on the capital of Apple Corporation? [Show all workings and formulae) [7.5 marks]
2. Samsung generates pre-tax earnings of $2,000,000 per year. Currently it has issued 1 million shares which sell for $10 each. Samsung has no debt in its capital structure. It is proposing a deal, which will allow it to borrow $5 million at 8% and buy back 500,000 shares and cancel them.
Required
a. What will be the share price after the deal? b. What is the weighted average cost of capital before and after the deal? [15 marks]
3. Nokia is all equity financed (that is it has no debt). Its shares have a return of 10%.
Du is the same as Etisalat. It is predicting cash flows before tax and interest of $3 million a year for ever. The management of Du are trying to decide on their financing arrangements and face three scenarios: * Scenario 1: Borrow no money * Scenario 2: Borrow $5 million at an interest rate of 6% with the balance coming from equity. * Scenario 3: Borrow $10 million at an interest rate of 8% with the balance coming from equity.
In all three cases Du will have 1 million shares.
Required
c. What will the share price under each scenario? [7.5 marks]
d. What is the weighted average cost of capital? [10 marks]
e. Discuss the advantages and disadvantages that may accrue to a firm and its shareholders, of the firm finances its projects using debt. [25 marks]
PART B 1. Discuss the