XYz Lid has an shoun below nory-share capital strocture Selectod Snascial dats f

Question

XYz Lid has an shoun below nory-share capital strocture Selectod Snascial dats for the compeu Ordinary sbare cutstandiag Ordinary share price, Expecoed leved of EHIT Dividend pay out ratio Assomption: No cospany tax), 3,001 000 S10 per share a) Under the present capital structare, whot is the tored vabue of the compary b) What is the oosl of ordisary share cspital, K c) What is the composite cus of capital, K d) Now suppose that XYZ sells s 1 milion of loo-term der within inmxrne er 8% The proceeds are used so raire ordisary shares Accieang to the indopendence hypothesis, what will be the company's structure change? What will be the dividends per share flowing to the oompary's ordinary e) s ordincery shareholders By what percentage has the diJidetd per share darum, as a result uf the capital structure change? What will be the corpceite ost of eapital after the capild-structure change? h) By what percentage has the cost of ordinary equiny changed as a result of the capital saructure change?

Explanation / Answer

(a) Value of the company = $ 10 x 2,000,000 = $ 20,000,000

(b) Cost of Capital = $ 5,000,000 / $ 20,000,000 x 100 = 25%

(c) Composite cost of capital = 25% i.e. same as cost of Ordinary capital as there is no debt capital

(d) After capital structure change

    Expected EBIT = $ 5,000,000 - ($ 1,000,000 x 8%)

                             = $ 4,920,000

    Ordinary Capital = $ 20,000,000 - $ 1,000,000 = $ 19,000,000

    Cost of Ordinary Capital = $ 4,920,000 / $ 19,000,000 x 100

                                           = 25.89%

(e) Dividend per share flowing to the company's ordinary shareholder = ($ 4,920,000 x 100%) / $ 1,900,000

                                                                                                               = $ 2.589 per share

(f) Orginal Dividend per share = ($ 5,000,000 x 100%)/ $ 2,000,000

                                                = $ 2.5 per share

     Percentage change in dividend per share = ($ 2.589 - $ 2.5)/$ 2.5 x 100 = 3.56% increase

     i.e. there is a 3.5% increase in dividend per share due to change in capital structure

(g) Composite cost of capital after capital structure change

       = (8% x $ 1,000,000 / $ 20,000,000) + (25.89% x $ 19,000,000 / $ 20,000,000)

       = 24.9955% or 25% (approx.)

(h) Percentage change in cost of Ordinary capital due to change in capital structure = (0.2589 - 0.25) / 0.25 x 100

                                                                                                                                     = 3.56% increase

      i.e. there is a 3.56% increase in cost of ordinary capital due to change in capital structure.

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