Dillinger Plc has the following capital structure: Equity: Ordinary shares - £1,000,000 issued with a nominal value of £0.20 and a market value of £0.65 Preference Shares - £260, 000 issued with a nominal value of £0.45 and a market value of £0.40. The annual (recurring) dividend of 8.5% has just been paid. Debt: Bonds - £100, 000 of 6% irredeemable bonds with a market value of £104 per £100. The annual interest payment has just been made. • The company pays corporation taxation at the rate of 30%. • The risk-free rate of return is estimated to be 2% and the market rate of return is estimated to be 2.55 times the risk-free rate. • The beta is 0.8. 1) Calculate the after-tax cost of capital for Dillinger Plc. 2) Identify and discuss the criticisms that can be made of the dividend model when it is used to estimate the cost of equity capital. 3) The directors of Dillinger Plc are about to conduct a review of the organisation’s capital structure and cost base. Draft a memorandum to the directors of Dillinger that discusses the advantages and disadvantages of: i) Increasing financial gearing ii) Increasing operating gearing
Dillinger Plc has the following capital structure:
Equity:
Ordinary shares - £1,000,000 issued with a nominal value of £0.20 and a market value of £0.65
Debt:
Bonds - £100, 000 of 6% irredeemable bonds with a market value of £104 per £100. The annual interest payment has just been made.
• The company pays corporation
• The risk-free
• The beta is 0.8.
1) Calculate the after-tax cost of capital for Dillinger Plc.
2) Identify and discuss the criticisms that can be made of the dividend model when it is used to estimate the
3) The directors of Dillinger Plc are about to conduct a review of the organisation’s capital structure and cost base. Draft a memorandum to the directors of Dillinger that discusses the advantages and disadvantages of:
i) Increasing financial gearing
ii) Increasing operating gearing
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