Response to the following problem:
NC Ltd Company and currently, it has no debt and expects to earn N$ 10million in net operating income each year for the foreseeable future. The required return on assets for the construction companies of this type is 12%, and the corporation tax is 40%. the manager of NC Ltd are weighing two capital structure alteration proposal as follows:
Proposal 1:
Borrow N$ 20million at an interest rate of 6 per cent and use the proceeds to repurchase an equal amount of outstanding stock. with this level of debt, the likelihood that NC Ltd will fall into bankruptcy in an given year will be 15 per cent, and if bankruptcy occurs then it will impose direct and indirect costs totalling N$ 12 million.
Proposal 2:
Borrow N$ 20million at an interest rate of 8 per cent and use the proceeds to repurchase an equal amount of outstanding stock. with this level of debt, the likelihood that NC Ltd will fall into bankruptcy in an given year will be 25 per cent, and if bankruptcy occurs then it will impose direct and indirect costs totalling N$ 20 million.