Light Speed plc requires £1,500,000 to fund a new project. The firm expects to earn an EBIT of £200,000 p.a. in perpetuity. Assume the project does not affect the operating risk of the company. The company intends to finance the project by issuing £1 million of 5% debentures at par and £1 million's worth of ordinary shares. The current capital structure of the company is as follows: MV (£'000) Debt (riskless) Equity The corporation tax rate is 25%. There is no time lag between taxable flows and the tax payments or receipts arising from those flows. Assume the required return on the market portfolio is 18% and the risk-free rate is 6%. Ignore income tax. 5,000 Required Return (%) 15,000 6 18 Required: Evaluate how the change of capital structure affects the company value and dividends. You should clearly specify your choice of gearing model and comment on how different models/assumptions made would/would not affect the results.
Light Speed plc requires £1,500,000 to fund a new project. The firm expects to earn an EBIT of £200,000 p.a. in perpetuity. Assume the project does not affect the operating risk of the company. The company intends to finance the project by issuing £1 million of 5% debentures at par and £1 million's worth of ordinary shares. The current capital structure of the company is as follows: MV (£'000) Debt (riskless) Equity The corporation tax rate is 25%. There is no time lag between taxable flows and the tax payments or receipts arising from those flows. Assume the required return on the market portfolio is 18% and the risk-free rate is 6%. Ignore income tax. 5,000 Required Return (%) 15,000 6 18 Required: Evaluate how the change of capital structure affects the company value and dividends. You should clearly specify your choice of gearing model and comment on how different models/assumptions made would/would not affect the results.
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
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Light Speed plc requires £1,500,000 to fund a new project. The firm expects to earn an EBIT of £200,000 p.a.
in perpetuity. Assume the project does not affect the operating risk of the company. The company intends to
finance the project by issuing £1 million of 5% debentures at par and £1 million's worth of ordinary shares. The
current capital structure of the company is as follows:
MV (£'000)
Debt (riskless)
Equity
The corporation tax rate is 25%. There is no time lag between taxable flows and the tax payments or receipts
arising from those flows. Assume the required return on the market portfolio is 18% and the risk-free rate is 6%.
Ignore income tax.
5,000
Required Return (%)
15,000
6
18
Required:
Evaluate how the change of capital structure affects the company value and dividends. You should clearly specify
your choice of gearing model and comment on how different models/assumptions made would/would not affect
the results.
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