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Aaron is an accountant who specializes in corporate taxes at Anderson & Westerhouse, a large accounting firm. Aaron has worked at A&W for five years and is hoping to be named a partner next year. His coworker Anne, who was hired at the same time as Aaron, also seeks to be named a partner, but it is not likely that A&W would name two new partners in the same year. Aaron and Anne have been in competition since they were both hired and have never cared for each other. About a year ago, Anne found an error in a report that Aaron had prepared and seized the opportunity to publicly embarrass Aaron in front of the senior partners. Aaron nearly lost his job as a result of Anne’s actions and has never forgotten it. Now the tables have turned and Aaron has found an error in Anne’s work. He sees this as a perfect opportunity to get revenge on Anne and help ensure that he is named the next partner

1. What might Aaron do? What would you do? 2. What are the possible ramifications of Aaron exposing Anne’s error? 3. How might Aaron resolve the conflict with Anne?

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(a) Explain fully the effect of the use of debt capital on the weighted average cost of capital of a company. (6 marks) (b) Millennium Investments Ltd. wishes to raise funds amounting to Sh.10 million to finance a project in the following manner: Sh.6 million from debt; and Sh.4 million from floating new ordinary shares. The present capital structure of the company is made up as follows: 1. 600,000 fully paid ordinary shares of Sh.10 each 2. Retained earnings of Sh.4 million 3. 200,000, 10% preference shares of Sh.20 each. 4. 40,000 6% long term debentures of Sh.150 each. The current market value of the company’s ordinary shares is Sh.60 per share. The expected ordinary share dividends in a year’s time is Sh.2.40 per share. The average growth rate in both dividends and earnings has been 10% over the past ten years and this growth rate is expected to be maintained in the foreseeable future. The company’s long term debentures currently change hands for Sh.100 each. The debentures will mature in 100 years. The preference shares were issued four years ago and still change hands at face value. Required: (i) Compute the component cost of: – Ordinary share capital; (2 marks) – Debt capital (2 marks) – Preference share capital. (2 marks) (ii) Compute the company’s current weighted average cost of capital. (5 marks) (iii) Compute the company’s marginal cost of capital if it raised the additional Sh.10 million as envisaged.

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