Fundamentals of Financial Management
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(a)company Acompany B1Dividend per share (2016)16.403.662Earnings per share (2016)32.8012.203Dividend cover ratio (1/2)0.50.34Retention ratio (1.00-3)0.50.75Return on equity0.0750.05856Growth ratio (4Ă—5)0.03750.040957Div1 Â [1Ă—(1.00+6)]17.0153.818Current share price463.0250.59Cost of equity (7/8+6)0.07420.05616(b)company Acompany B1share price4.632.5052No. of shares3260300007156610003market to book value1.461.154equity market value(1Ă—2)150951890017927308055equity book value(4/3)103391705515588963526capital gearing28.36%56.21%7debt book value(5Ă—6/(1-6))409294914.520010405118debt market value409294914.520010405119capital market value(4+8)1918813814379377131610cost of debt4%4%11cost of equity7.42%5.62%12tax rate19%19%13the weight of equity of merged company(4/(9A+9B))26.42%47.25%14the weight of debt of merged company(8/(9A+9B))7.16%35.03%15the overall cost(10Ă—14AĂ—(1-12)+10Ă—14BĂ—(1-12)+11AĂ—13A+11BĂ—13B)5.98%
(c)company Acompany Bthe merged company1debt book value409294914.520010405112cost of debt4%4%3interest(1Ă—2)16371796.5880041620.42964134174earnings per share0.3280.1225No. of shares3260300007156610006NI(4Ă—5)106937840873106427tax rate19%19%8EBT(6/(1-7))132022024.7107790916.0239812940.79EBIT(8+3)148393821.3187832536.5336226357.710the overall interest cover(9/3)9.062.353.49(d)Capital structure refers to the ratio of corporate debt financing and equity financing. Whether the capital structure will affect the value of the company, in the companys financial theory so far is still an unsolved mystery. In a sound capital market situation, the capital structure will not influence the value of the enterprise. As in the MM theory, the firms value is not affected by the capital structure when there is no corporate income tax and transaction costs and there is a full arbitrage opportunity in the market. The weighted capital cost remains the same and the companys value depends only on EBIT. However, the capital market there are three major shortcomings, namely, asymmetric tax burden, asymmetric information and transaction costs. Because of the existence of these defects, the capital structure will affect the value of the company. Therefore, considering corporate tax the MM theory support that the interest can be levied before the tax, the dividend can only be deducted after tax, this tax burden asymmetry makes debt financing cheaper than equity financing, so debt can increase the value of the company. However, the theory of agency costs and trade-offs have different views on the impact of liabilities on corporate value. The agency cost theory argues that there is a conflict of interest between the shareholders, the creditor and the manager. The debt may decrease the value of the firm because of the agency cost from the conflict of interest, but the supervisory effect of the liability may also reduce the agency cost and increase the value of the company. Similarly, the trade-off theory suggests that an increase in liabilities would result in expected bankruptcy costs, which would offset the leverage benefits of tax burden asymmetry, and that debt would not be better. The extent of the companys liability depends on the trade-off between the leverage benefits and the expected bankruptcy costs. Pecking order theory analyses the financing behaviour of the company from the perspective of information asymmetry. Compared to external financing, the company is more inclined to internal accumulation, if the company needs external financing, equity financing will be considered before the debt financing. By means of financing the way, the capital structure can affect the value of the company.