Britannia Co. is planning to invest into the carriage trade. Before any analysis of the cash flows can begin, the CEO must select an appropriate discount rate. The accountant suggests the calculation of the cost of capital.

The following is the existing (book value) capital structure of the company.

Debentures (Original maturity 18 years) $20,000,000

Preferred Shares 4,000,000

Common Shares 8,000,000

Returned Earning 16,000,000

Foreign Currency Translation 2,000,000

TOTAL $50,000,000

The yield on 91-day Government of Canada TB is currently 11.78%. The debentures, which have been

outstanding for three years, have a coupon rate of 14%. Current market yields on this risk security are

currently about 12.5%. Flotation costs would be 2% of the issue price.

The preferred shares with a fixed dividend rate of 7% currently trade at a market value of $3,000,000.

Flotation expenses of a new issue of preferred would be 3% of the issue price. The common shares, of

which there are 5 million outstanding, are currently priced at $5.00 per share. The current dividend is

$0.10 per share. Britannia's beta is 1.2 and its projected growth rate is 16% annually, particularly if this

new project does not turn into a pumpkin. Flotation expenses would be 5% of the existing share price.

The tax rate is 41% and the current exchange rate is 1 Canadian dollar equal to $0.86 U.S.

Notes: I have already calculate the e WACC. Using the market value weightings.

WACC: 13.16%

Question:

Using the weighted average cost of capital, explain how the current tax structure encourages

 

firms to increase their use of leverage?

Answer rating: 100% (QA)

How the Current Tax Structure Encourages Leverage based on Britannia Cos WACC While the WACC calculation itself doesnt directly show the tax benefit o... View the full answer