QUESTION 2

(12 marks)

Pipe Ltd is a totally equity-financed company with a value of R200 000,00. Management wants to introduce a 30% debt in the capital structure without altering the total amount of financing required (R200 000,00). Pipe Ltd's shares are trading at R10,00 per share and the company pays all its earnings as dividends. The details of the new 30% debt ratio are listed below: Debt ratio 30% EBIT R100 000,00 Interest rate 11.5% Required return 14% Tax rate 28%

REQUIRED

2.1 Calculate the number of shares that can be issued irrespectively under the current and proposed capital structures.

2.2 Based on earnings per share, advise management whether they must introduce the 30% debt or retain the totally equity financed capital structure.

2.3 Which capital structure would you advise the company to choose if the aim is to maximise shareholder wealth? (Note that the share price must be the basis of your argument).