Yamate Limited wishes to calculate its weighted average cost of capital and the following information relates...

 

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Yamate Limited wishes to calculate its weighted average cost of capital and the following information relates to the company at the current time: Number of ordinary shares Book value of 7% convertible debt Book value of 8% bank loan Market price of ordinary shares Market value of convertible debt Equity beta of the company Risk-free rate of return Equity risk premium Rate of taxation After tax cost of convertible debt 20 million $29 million $2 million $5.50 per share $107.11 per $100 bond 1.2 4.7% 6.5% 30% 6% The company expects share prices to rise in the future at an average rate of 6% per year. The convertible debt can be redeemed at par in eight years' time or converted in six years' time into 15 shares per $100 bond. Required: (a) Calculate the market value weighted average cost of capital of the company. State clearly any assumptions that you make. (15 marks) (h) "In finance, the most debatable topic is capital structure. The main issue of debate revolves around the optimal capital structure. There are two schools of thought in this regard. One school pleads for optimal capital structure and other does against it. Former school argues that judicious mixture of debt and equity capital can minimize the overall cost of capital and maximize the value of the firm. Hence, this school considers capital structure decision as relevant. Latter school of thought led by Modigliani and Miller contends that financing decision does not affect the value of the firm. Since value of the firm depends on the underlying profitability and risk of investment (Van Horne 2002)." Critically evaluate the above quotation in the light of the overwhelming research evidence of capital structure theory. (35 marks) In this section students should demonstrate both understanding and knowledge of the capital structure theoretical viewpoints. The discussion / evaluation should be supported with relevant empirical research that has been performed within this area and should be referenced accordingly. The inclusion and ability to integrate real-life practical business examples, addressing whether differing companies adopt different capital structure strategies would assist in developing the response in greater depth and detail. Total for Part B - 50 marks Yamate Limited wishes to calculate its weighted average cost of capital and the following information relates to the company at the current time: Number of ordinary shares Book value of 7% convertible debt Book value of 8% bank loan Market price of ordinary shares Market value of convertible debt Equity beta of the company Risk-free rate of return Equity risk premium Rate of taxation After tax cost of convertible debt 20 million $29 million $2 million $5.50 per share $107.11 per $100 bond 1.2 4.7% 6.5% 30% 6% The company expects share prices to rise in the future at an average rate of 6% per year. The convertible debt can be redeemed at par in eight years' time or converted in six years' time into 15 shares per $100 bond. Required: (a) Calculate the market value weighted average cost of capital of the company. State clearly any assumptions that you make. (15 marks) (h) "In finance, the most debatable topic is capital structure. The main issue of debate revolves around the optimal capital structure. There are two schools of thought in this regard. One school pleads for optimal capital structure and other does against it. Former school argues that judicious mixture of debt and equity capital can minimize the overall cost of capital and maximize the value of the firm. Hence, this school considers capital structure decision as relevant. Latter school of thought led by Modigliani and Miller contends that financing decision does not affect the value of the firm. Since value of the firm depends on the underlying profitability and risk of investment (Van Horne 2002)." Critically evaluate the above quotation in the light of the overwhelming research evidence of capital structure theory. (35 marks) In this section students should demonstrate both understanding and knowledge of the capital structure theoretical viewpoints. The discussion / evaluation should be supported with relevant empirical research that has been performed within this area and should be referenced accordingly. The inclusion and ability to integrate real-life practical business examples, addressing whether differing companies adopt different capital structure strategies would assist in developing the response in greater depth and detail. Total for Part B - 50 marks