Light Speed plc requires £2,000,000 to fund a new project. The firm expects to earn an EBIT of £250,000 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 millions 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) Required Return (%) Debt (riskless) 4,000 5 Equity 16,000 15 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 15% and the risk-free rate is 5%. Ignore income tax. Evaluate how the change of capital structure affects the company value and dividends.
Light Speed plc requires £2,000,000 to fund a new project. The firm expects to earn an EBIT of £250,000 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 millions 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) Required Return (%) Debt (riskless) 4,000 5 Equity 16,000 15 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 15% and the risk-free rate is 5%. Ignore income tax.
Evaluate how the change of capital structure affects the company value and dividends.
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