Financial management revision question & answer

Assume that on 31 December 2001 you are provided with the following capital structure of Hatilcure Ltd which is optimal.
The company has total assets amounting to sh.360 million but this figure is expected to rise to Sh.500 million the end of 2002. You are also informed that:

1. Any new equity shares sold will net 90% after flotation costs.
2. For the year just ended the company paid Sh.3.00 in dividends per share.
3. New 16% debt can be raised at par through the stock exchange.
4. The past and expected earnings growth rate is 10%
5. The current dividend yield is 12%
6. The company‟s dividend payout ratio of 50% shall be maintained in 2002.
7. Assume marginal at rate of 40%

8. The company‟s capital structure is optimal

Required:
a) Company‟s net amount to the capital budget to be financed with equity if 85% of the
asset expansion is included in the 2002 capital budget.
b) How many shares must be sold to raise the required equity capital? Round your figure to the nearest thousand.
c) What is the firm‟s marginal cost of capital? Show full workings.
answer

a) Amount of capital to raise = 500M – 360M = 140M

Amount to raise in 1996 = 85% x 140M = 119M
Since the existing capital structure is optimal, the Sh.119M would be raised as follows:

b) Determine the market price per share

Dividend yield = 12% = 0.12

MPS net of floatation cost = Sh.25 x 90% = 22.50

Amount to raise from issue of ordinary shares = Sh.35,700,000 Issue price per share = Sh.22.50


c) Compute the marginal cost of each source of finance Marginal cost of equity

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