Reference no: EM133146313

Question - (a) Miller pc has annual profits before interest and tax of £20 million. These profits are expected to remain the same into perpetuity.

The market price of the company's ordinary shares is £1.35 per share cum-div and the debenture sells at £95.75 per debenture ex-interest. An interim dividend of 5 pence per share has been declared. Corporate tax is at the rate of 30 percent and all available earnings are distributed as dividends.

Miller Long-Term capital structure is shown below: £'000

Ordinary shares (50 pence par value) 25,000

Reserves 50,800 75,800

12% Debenture due 31s December 2020 23,697 99,497

The current after corporate tax yield to maturity on the company's debenture is 8.65 percent

Required - Calculate the weighted average cost of capital of Miller ple according to the traditional view of capital structure and analyse the implications of the calculation for the value of the firm. Assume its is now 31st December 2018.

(b) Max Inc. is an all equity firm with an equilibrium market value of £42.5 million and a cost of capital of 16 percent. The company proposes to repurchase £7 million of equity to replace it with a 11 percent irredeemable loan stock.

Max's earnings before interest and tax are expected to be constant for the foreseeable future. Corporate tax is at the rate of 30 percent. All profits are paid out as dividends.

Required - Using the assumptions of Modigliani and Miller, explain and show how this change in capital structure will affect:

the total market value of the firm:

the market value of equity:

the cost of equity capital

the weighted average cost of capital of Max