james PLC one of the companies listed on the stock exchangewishes to calculate its updated weighted Average cost of capitalfor use in the investment appraisal process.
$'
Million
Issued shared capital ($100 shares 2,000
Share premium 1,300
Reserves 145
Share Holders funds 3,445
6% irredeemable Debentures 1,400
9% Redeemable Debentures 1,450
Bank loan 500
Total Long - Term liabilities 3,350
The current cumulative interest market value per $100units is $103 and $105 for the 6% and 9% debentures respectively.The 9% denture is redeemable at par in 10 years' time. The bankloan bears interest rate of 2% above the base rate (current baserate is 15%). The current ex-div market price of shares is $1,100and a divided of $100 per share which is expected to grow at a rateof 5% per year has just been paid. The effective corporation taxrate for James PLC is 30%.
Required
(a) Calculate the effective after tax Weighted Averagecost of Capital (WACC) for James PLC.
(b) Using the traditional theory of capital structureexplain what would happen if the company took on additional debtfinance.
