WEB Co. operates a low cost airline and is a listed company. By comparison to its major competitors it is relatively small, but it has expanded significantly in recent years. The shares are held mainly by large financial institutions. The following are extracts from WEB cos. Budgeted statement of financial position at 31st May 2012.
$M
Ordinary share of $ 1 100
Reserves 50
9% Bonds 2015(at nominal value) 200
350
Dividends have grown in the past at 3% a year, resulting in an expected dividend of $ 1 per share to be declared on 31st May 2012.Due to expansion, dividends are expected to grow at 4% a year from 1st June 2012 for the foreseeable future the price per share is currently $10.40 ex divan this is not expected to change before 31st May 2012.
The existing bonds are due to be redeemed at par on 31st May 2015.the market value of these bonds at 1st June 2012 is expected to be redeemed at par on 31st May 2012 is expected to be $100.84(ex interest)per $ 100 nominal. Interest is payable annually in arrears on 31st M ay and is allowable for the tax purposes .tax is payable on profit at a rate of 30%.Assume taxation is payable at the end of the year in which the taxable profits arise.
New finance
The co. has now decided to purchase three additional aircraft at a cost of $10 million each.
The board has decided that the new aircraft will be financed in full by a 8% bank loan on 1st June 2012.
Required:
a) Calculate expected weighted average cost of capital of WEB Co. at 31st May 2012.
(8 marks)
b) Without further calculations, explain the impact of the new bank loan on WEBs cos.
Cost of equity
Cost of debt
Weighted average cost of capital (using traditional model) (8 marks)
c) Explain and distinguish
Bank loan
Bonds
d) Explain why WEB might decide to raise capital in the form of convertible debt issue rather than straight equity or debt.(5 marks)
e) Discuss ways in which the agency problem could be dealt with in public ltd co.(5 marks)
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