# Cost of capital and Capital structure.

accounting question and need an explanation and answer to help me learn.

Topic:Cost of capital and Capital structure
Assignment instructions:
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, 28p
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%.
You are required to:
1) Calculate the book value and market value cost of capital (WACC) for ABC plc. (35marks)
2) 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. (35marks)
3) Critically analyse whether you consider that organisations, by integrating a sensible level ofgearing into their capital structure, can decrease their WACC, ensuring the response integrates relevant empirical research within this area of study. (30 marks)
Requirements: | .doc file
Topic: Cost of capital and Capital structureAssignment instructions: The CFO of ABC plc is analysing the capital structure of the organisation. He claims that ABC is notfinancing itself in a way which reduces its cost of capital (WACC). The information below representsthe ABC’s financing as at 31 December 2016: £000Ordinary shares, £1 each20000Reserves50007% preference shares, £1 each1000010% bonds (irredeemable 31 December 2016)15000Total capital50000 Other information from stock market (as at 31December 2016): Ordinary share price (ex-div) £2.65Preference share price (ex-div) 75p Bond price for 10% bonds £107 per £100 Last 5 years’ dividends (most recent last) 21p, 23p, 25p 27p, 28p 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 willmature after 7 years. The money will be used to repurchase ordinary shares which ABC will furthercancel. The CFO presumes that repurchasing will result in the organisation’s share price rise to£2.85 and the future dividend growth rate to grow by 20% (relatively). He anticipates the price of the10% bonds to be unaffected, but the price of the preference shares to drop to 68p. Corporate taxstands at 30%.
You are required to: 1) Calculate the book value and market value cost of capital (WACC) for ABC plc. (35 marks) 2) Considering the proposed changes to ABC’s capital structure, recalculate theorganisation’s cost of capital to reflect these changes and comment on the CFO’sforecasts. (35 marks) 3) Critically analyse whether you consider that organisations, by integrating a sensible levelof gearing into their capital structure, can decrease their WACC, ensuring the response integratesrelevant empirical research within this area of study. (30 marks) Common requirements:- Critical analysis;- Correct application of Harvard Referencing style;- Support your claims with relevant academic sources;- Proper application of financial management techniques;- Clean and clear presentation including structure, style, clarity and visuals. What we are looking for:- Your own work free of plagiarism;- Clear demonstration of computations;- You knowledge of financial management techniques and their application;- Your ability to prepare financial reports;- Your critical thinking. Do NOT:
– Copy paste or rewrite another author’s work;- Use such sources as Wikipedia, Investopedia and similar;- Go over the word count limit (maximum deviation is +10%);- Include straight answer without supporting calculations. Powered by TCPDF (www.tcpdf.org)