Almac Plc is a pharmaceutical company that traditionally has not used debt to finance its projects. Over the last 5 years, it has also reported high returns on its projects and growth and made substantial research and development expenses over the period. The health care business overall is growing much slower now, and the projects that the firm is considering have lower expected returns.

a) How would you justify the firms past policy of not using debt?

1. Do you think the policy should be changed now? Explain your answer.

3. Discuss three factors that Almac Plc should consider when choosing a source of debt finance.

d) In 2021, Almac Plc, the all-equity company had an equilibrium market value of 32.5 million and a cost of capital of 18% per year. The company proposes to repurchase 5 million of equity and to replace it with 13% irredeemable loan stock. Almacs earnings before interest and tax are expected to be constant for the foreseeable future. Corporate tax is at the rate of 35%. All profits are paid out as dividends.

Use Modigliani and Millers model with corporate tax to demonstrate how this change in the capital structure of Almac plc will affect its:

1. Market value

2. Cost of equity

3. Weighted average cost of capital