Part A of this assignment requires an analysis of certain aspects of "Brown Ltd"
After studying "Brown Ltd", answer the following questions:
Assuming that -
- Brown has no uncommitted internal funds which can be applied to financing the proposed expansion and replacement program;
- Brown will finance any funding shortfall (after the proposed capital restructuring) with new debt. Brown's cost of equity will remain at 11% after tax, irrespective of changes to its debt ratio (i.e. the ratio of market value of total long-term debt to market value of total long-term funds) -
Justify your answers to the following questions with full explanations, including, where applicable, itemised schedules of relevant capital structure components.
(a) Quantify Brown's debt ratio before and after the capital restructuring.
(b) Quantify Brown's WACC before and after the capital restructuring.
(c) What discount rate did you use to evaluate the investment alternatives offered by the proposed capital expansion and replacement program? Justify your answer.
Existing Capital Structure
The present capital structure of the company is shown below. The current market value of the company's $1 ordinary shares paid to 50c is 85c. The company's debentures are currently quoted at their nominal value. On the basis of the above market value of ordinary shares the company's cost of equity capital is estimated at 11 per cent. Any new debt can be obtained at 7%.
Capital Structure as at 30 June 2011
