Financial management revision question and answer

CPA-Financial-Management-Section-3 Revision kit

The Finance Manager of Mapato Limited has compiled the following information regarding the company‟s capital structure. (4 marks)

Ordinary shares
The company‟s equity shares are currently selling at Shs. 100 per share. Over the past five years, the company‟s dividend pay-outs which have been approximately 60% of theearnings per share were as follows:

Year ended 30 September Dividend per share

Shs.
Financial management revision question and answer

Shs

2004                                        6.60
2003                                        6.25
2002                                        5.85
2001                                         5.50
2000                                        5.23

The dividend for the year ended 30 September 2004 was recently paid.

The average growth rate of dividend is 6% per annum.
To issue additional ordinary shares, the company would have to issue at a discount of Shs. per share and it would cost Shs. 5 in floatation cost per share.

The company can issue unlimited number of shares under the above terms.

Preference shares
The company can issue an unlimited number of 8% preference shares of Shs. 10 par value at a floatation cost of 5% of the face value per share.

Debt
The company can raise funds selling Shs. 100, 8% coupon interest rate, 20 year bonds, on which annual interest will be made.

The bonds will be issued at a discount of Shs. 3 per bond and a floatation cost of an equal amount per bond will be incurred.

Capital structure
The company‟s current capital structure, which is considered optimal, is:
Shs.
Long term debt                30,000,000
Preference shares            20,000,000
Ordinary shares               45,000,000
Retained earnings           5,000,000
100,000,000
The company is in the 30% tax bracket.
Required:
(i) The specific cost of each source of financing.
(ii) The level of total financing at which a break even point will occur in the
company‟s weighted marginal cost of capital.
ANSWER

(i)

(ii) Break = Source with lowest cost (Amount)
Weight of the source

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