Question

Question 3 (25) Mats Ltd is a company that produces and sells welcome mats through a network of retail outlets Company management has decided that the company also needs an online presence and wants to raise capital to create a high quality online store and build warehouses for distribution purposes Currently, the company has R100 million in debt and R200 million in assets and R50 million of its equity is retained earnings, which management wishes to use before it issues new debt The company can issue bonds up to R50 million, after which it can issue equity (through a nights issue) up to the required amount The company requires R150 million in capital for its expansion plans, which will be raised as per the guidelnes from management The company can obtain capital as follows • Up to 5000, ten year, R10 000 par value, 15% annual coupon (paid at the end of each year), bonds can be issued at R9 500 per bond Up to 2 million shares can be issued in a renounceable nghts issue at a subscription price of R50 each (ignore any issuance or transaction costs) The current market price of the company's shares is R50, and it is expected that 50% of existing shareholders will exercise their nghts and that the remainder will transfer their rights to a third party There are currently 1 million shares in issue Assume that the company has an unlevered beta of 0,50, is taxed at a rate of 28% and issuance and transaction costs are negligible The risk-free rate is 8% and the market risk premium 6% The company has a target debt to equity ratio of 0,8 (debt ratio of 44,44%) Required. a) Determine how much capital the company will need to raise from each source of financing (if at all) b) Calculate the cost of each source of financing c) Determine the weighted average cost of capital (WACC) for the company d) Discuss the new WACC of the company, the financial risk profile of the company and how control of the company may be affected (show your calculations regarding control) e) Elaborate on the type of capital structure approaches (or theories) that can be observed in this case study 1) Briefly discuss which type of financing would most likely be sourced next, considering the target capital structure

Answer 1

Ang3 Cworently, as por question < Assets - Deb 2200-Rlo0 - Rloo millian Dest. Assets = R loomillien Equity R200 million Retained Earmings = R5o million Max bond amount = R50 millien. which can be issued Roquire me nt =fso millien. NoW, Unlevered Bota =0.50. 28/ sklree Rate =8 (Rm-R]market RurGem = 6%> Capital fuom each sowice Bondls All If Tetan Bonds issued, Then to tal capital aised = 5000 XAlO 000 R50 milli on Equity Totas Reguiore ment- Capitel forom Bond RISO million- R Somillion R loo million

7 Cast of Bonds AI[I-T] + RV NE RV+NP 2. where AI=AnnudInterest T= Tax Rate RV= Ridomptien value NP- Net Bocods |S00 (1-0.23) t lojo00-9,500 To Cast of Bonds = To,000+930 Cost f Bonds 11.599% Rf+ B(Rm-Rf] Pl= Ruk frce fate ost el Egui ty = B= Levered Bete Rm-Rf=morret isk laemium Unlevered Beta 1+ Debt [-Tax Equity Lovered Beta %3D -0.5 (1+.!(0.72] -0.86. Cost of Egui ty = 8+ 086[6) Cost of Equity 13 160/0

C) t Cost of Debt (bebt Lotel (apite WACC = Cost of Equi ty Equity Total lapital ॥6१) 13:14 ( 1159(109) 200 Eqpity WACC = 12.375% New WACC 314[200 t1is1f150 13.16 350 350 New WACC = 12.4871 Cempamy Debt Ratio= 150 = 4285710 350 which is lower then ŷ t's tatget So Company can i she more debt.