Weighted Average Cost of Capital Assignment | Homework For You

Manny Co is a listed company that plans to spend $10m on expanding its existing business. It has been suggested that the money could be raised by issuing 9% loan notes redeemable in ten years’ time. Current financial information on Manny Co is as follows.Homework For You

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Income statement information for the last year


Profit before interest and tax                                                                             7,000

Interest                                                                                                             (500)

Profit before tax                                                                                                6,500

Tax                                                                                                                  (1,950)

Profit for the period                                                                                           4,550

Balance sheet for the last year                                                  $000                 $000

Non-current assets                                                                                           20,000

Current assets                                                                                                  20,000

Total assets                                                                                                     40,000

Equity and liabilities

Ordinary shares, par value &1                                                   5,000

Retained earnings                                                                     22,500

Total equity                                                                                                      27,500

10% loan notes                                                                                     5,000

9% preference shares, par value $1                                           2,500

Total non-current liabilities                                                                                7,500

Current liabilities                                                                                               5,000

Total equity and liabilities                                                                                  40,000

The current ex div ordinary share price is $4.50 per share. An ordinary dividend of 35 cents per share has just been paid and dividends are expected to increase by 4% per year for the foreseeable future. The current ex div preference share price is 76.2 cents. The loan notes are secured on the existing non-current assets of Manny Co and are redeemable at par in eight years’ time. They have a current ex interest market price of $105 per $100 loan note. Manny Co pays tax on profits at an annual rate of 30%.

The expansion of business is expected to increase profit before interest and tax by 12% in the first year. Manny Co has no overdraft.

Average sector ratios:

Financial gearing: 45% (prior charge capital divided by equity capital on a book value basis)

Interest coverage ratio: 12 timesHomework For You


(a) Calculate the current weighted average cost of capital of Manny Co.

(b) Discuss whether financial management theory suggests that Manny Co can reduce its weighted average cost of capital to a minimum level.

(c) Evaluate and comment on the effects, after one year, of the loan note issue and the expansion of business on the following ratios:

(i) Interest coverage ratio;

(ii) Financial gearing;

(iii) Earnings per share.

Assume that the dividend growth rate of 4% is unchanged. Get Finance homework help today

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