The CFO of ABC plc is analysing the capital structure of the organisation. He claims that ABC is not financing itself in a way which reduces its cost of capital (WACC). The information below represents the ABC’s financing as at 31 December 2016: £000 Ordinary shares, £1 each 20000 Reserves 5000 7% preference shares, £1 each 10000 10% bonds (irredeemable 31 December 2016) 15000 Total capital 50000 Other information from stock market (as at 31December 2016): Ordinary share price (ex-div) £2.65 Preference share price (ex-div) 75p Bond price for 10% bonds £107 per £100 Last 5 years’ dividends (most recent last) 21p, 23p, 25p 27p, 28pv The CFO states that by issuing more debt ABC will lower its cost of capital. He suggests issuing £15m of 11 per cent bonds. These bonds will be sold at a 5%premium to their par value and will mature after 7 years. The money will be used to repurchase ordinary shares which ABC will further cancel. The CFO presumes that repurchasing will result in the organisation’s share price rise to £2.85 and the futuredividend growth rate to grow by 20%(relatively). He anticipates the price of the 10%bonds to be unaffected, but the price of the preference shares to drop to 68p. Corporate tax stands at 30%. 1:Considering the proposed changes to ABC’s capital structure, recalculate the organisation’s costof capital to reflect these changes and comment on the CFO’s forecasts.
The CFO of ABC plc is analysing the capital structure of the organisation. He claims that ABC is not financing itself in a way which reduces its cost of capital (WACC). The information below represents the ABC’s financing as at 31 December 2016:
|
£000 |
|
|
Ordinary shares, £1 each |
20000 |
|
Reserves |
5000 |
|
7% preference shares, £1 each |
10000 |
|
10% bonds (irredeemable 31 December 2016) |
15000 |
|
Total capital |
50000 |
Other information from stock market (as at 31December 2016): Ordinary share price (ex-div) £2.65
Last 5 years’ dividends (most recent last) 21p, 23p, 25p 27p, 28pv
The CFO states that by issuing more debt ABC will lower its cost of capital. He suggests issuing £15m of 11 per cent bonds. These bonds will be sold at a 5%premium to their par value and will mature after 7 years. The money will be used to repurchase ordinary shares which ABC will further cancel. The CFO presumes that repurchasing will result in the organisation’s share price rise to £2.85 and the futuredividend growth rate to grow by 20%(relatively). He anticipates the price of the 10%bonds to be unaffected, but the price of the preference shares to drop to 68p. Corporate tax stands at 30%.
1:Considering the proposed changes to ABC’s capital structure, recalculate the organisation’s costof capital to reflect these changes and comment on the CFO’s
Step by step
Solved in 2 steps with 2 images
