- 5 Marks
AFM – May 2018 – L3 – Q1c – Theories of capital structure
Calculating the WACC for different financing options and determining the optimal capital structure.
Question
Paisley Brothers Ltd, a company producing loud paisley shirts, has a net operating income of GH¢20,000 and is faced with the following three options for how to structure its debt and equity:
i) Take no debt and pay shareholders a return of 9%.
ii) Borrow GH¢50,000 at 3% and pay shareholders an increased return of 10%.
iii) Borrow GH¢90,000 at 6% and pay a 13% return to shareholders.
Assuming no taxation and a 100% payout ratio:
Required:
Calculate the Weighted Average Cost of Capital (WACC) for each of the options and determine which method is optimal. (5 marks)
Find Related Questions by Tags, levels, etc.
- Tags: Debt Financing, Equity Financing, Optimal Capital Structure, WACC
- Level: Level 3
- Topic: Theories of capital structure
- Series: MAY 2018