You need to solve this question in Excel . Your workings must be as detailed as possible.
Question:
You need to solve this question in Excel. Your workings must be as detailed as possible.
The Finance Director of Kosmos plc is currently reviewing the capital structure of the company. She is convinced that the company is too reliant on equity financing and thinks that the cost of capital figure (WACC) is therefore disproportionately high. The company's balance sheet as at 1 January 2023 is as follows:
000 | |
Ordinary shares, 1 each | 15,000 |
Reserves | 10,000 |
8% bonds (redeemable after 6 years at 100 par) | 5,000 |
30,000 | |
Other information (as at 1 January 2023): | |
Ordinary share price (ex-div) | 2.5 |
Market price for 8% bonds | 106 |
Corporate tax | 22% |
Last 5 years' dividends (most recent last) 20p, 22p, 15p, 28p, 38p
a) Calculate the current cost of capital (WACC) for Kosmos plc.(20 marks)
Additional Information:
The finance director thinks that by borrowing more, the company will be able to reduce its relatively high cost of capital. She proposes to take a substantial bank loan of 15m. Financial advisors believe that the bank will charge interest equivalent to the annual borrowing rate between 31.12.2025 and 01.01.2026 determined by the strips data presented below:
Strips at par 100 | ||||||
Maturity at year end | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 |
Current market prices () | 98 | 95 | 93 | 90 | 85 | 80 |
The funds raised will be used to repurchase ordinary shares which the company will then cancel. She expects the repurchase will cause the company's share price to rise to 3.2 and the future dividend growth rate to become 16%. The finance director expects the price of the originally issued 8 per cent bonds to be unaffected.
b) Given the proposed changes to Kosmos's capital structure, recalculatethe company's cost of capital. Comment on the change in the WACC.(20 marks)
c) Discuss theoretical concepts that describe the relationship between debt-to-equity ratio and the effect on the WACC. Relate your discussion to the results obtained in (a) and (b).(10 marks)
Corporate Finance Principles and Practice
ISBN: 978-1292103037
7th edition
Authors: Denzil Watson, Antony Head