The directors of Gamma plc are investigating the possibility of launching a new product line which will require an initial investment of £2,400,000. The following is an extract from the Statement of Financial Position of Gamma plc for the year ended 31 December 2012:Creditors due in more than one year 6% Debentures £1,600,000 Long-term loan £400,000 Capital and reserves Issued share capital (4 million shares of 25p each) £1,000,000 The following information is also available: The authorized share capital is 8 million shares; The current market price per share at 31 December 2012 was 162p ex-dividend; The last dividend payment was 17 pence per share; Dividends are expected to grow at a constant rate of 7% per year; The current market price of debentures is £95 (ex-interest) and interest is payable each year on 31 December. The debentures are irredeemable; The interest rate on the long-term loan is 0.5 percentage points above LIBOR, which at present stands at 4 per cent. Required Calculate the weighted average cost of capital of Gamma plc.Explain Modigliani and Miller’s argument that in a world of no taxes and no bankruptcy the value of the firm does not depend on its capital structure.Explain how a firm's optimal capital structure is determined according to the static theory of capital structure (i.e. the traditional approach).

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Answered: The directors of Gamma plc are…

Excel Applications for Accounting Principles

4th Edition

ISBN:9781111581565

Author:Gaylord N. Smith

Publisher:Gaylord N. Smith

ChapterMB: Model-building Problems

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The directors of Gamma plc are investigating the possibility of launching a new product line which will require an initial investment of £2,400,000.

The following is an extract from the Statement of Financial Position of Gamma plc for the year ended 31 December 2012:

Creditors due in more than one year
6% Debentures	£1,600,000
Long-term loan	£400,000
Capital and reserves
Issued share capital (4 million shares of 25p each)	£1,000,000

The following information is also available:

The authorized share capital is 8 million shares;
The current market price per share at 31 December 2012 was 162p ex-dividend;
The last dividend payment was 17 pence per share;
Dividends are expected to grow at a constant rate of 7% per year;
The current market price of debentures is £95 (ex-interest) and interest is payable each year on 31 December. The debentures are irredeemable;
The interest rate on the long-term loan is 0.5 percentage points above LIBOR, which at present stands at 4 per cent.

Required

Calculate the weighted average cost of capital of Gamma plc.
Explain Modigliani and Miller’s argument that in a world of no taxes and no bankruptcy the value of the firm does not depend on its capital structure.
Explain how a firm's optimal capital structure is determined according to the static theory of capital structure (i.e. the traditional approach).

Definition Definition Financial statement that provides a snapshot of an organization's financial position at a specific point in time. It summarizes a company's assets, liabilities, and shareholder's equity, detailing what the company owns, what it owes, and what is left over for its owners. The balance sheet serves as a crucial tool to assess the financial health and stability of a company, as well as to help management make informed decisions about its future investments and financial obligations.

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