If the company decides  to finance the project with debt capital, what factors  should it take into consideration before deciding on the source of the debt capital                                           b). Discuss how the decision to finance the project with debt capital will affect the return  to equity shareholder taking into consideration the 1958 M@ M irrelevance Proposition 2 argument.                         c). Discuss any weaknesses of both the traditional capital structure    and the Modigliani and Miller irrelevance proposition  theories  of capital structures  and  discuss how useful  they might be in the determination of the appropriate capital structure of Asempa limited

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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Asempa  limited which manufactures  household utensils  is currently financed by  four million ordinary shares of  GHS1.00 each par value. The shares have a market value of  GHS3,50 per share, No debt finance has been used by the company. At a recent emergency board meeting to discuss the way forward as a results of the negative impact of the COVID 19 pandemic on the performance of the company, the managing Director proposed  to undertake a massive project expansion next year and suggested that the proposed project will be financed entirely by fixed interest debt , He proposed that,  the project be financed by GHS5,000,000 irredeemable debentures to be issued at par. The company’s  Director of finance  indicated that it is  only possible to obtain debt finance equal to the entire cost of the project as Asempa has  previously been all equity financed and has therefore considerable unused borrowing capacity. According to his calculation after obtaining the debt capital for the project, Aempa will be at  level  of  gearing which will be optimum to the company. Asempa’s  management team are, in principle , in favour of the expansion but  there is considerable opposition to the use of debt finance   and it is suggested that the project be funded by an issue of shares at their full market price..

Required:

a).  If the company decides  to finance the project with debt capital, what factors  should it take into consideration before deciding on the source of the debt capital                                          

b). Discuss how the decision to finance the project with debt capital will affect the return  to equity shareholder taking into consideration the 1958 M@ M irrelevance Proposition 2 argument.                        

c). Discuss any weaknesses of both the traditional capital structure    and the Modigliani and Miller irrelevance proposition  theories  of capital structures  and  discuss how useful  they might be in the determination of the appropriate capital structure of Asempa limited.

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