advanced financial management, Financial Management

QUESTION 1 [25 marks]
Xelo Ltd, whose current sales consist of fixed operating costs of R140 000 and variable operating costs equal to 22% of sales, has made the following two sales estimates with their noted probabilities.
Sales
Probabilities
R450 000
0.35
R710 000
0.65
Xelo Ltd is currently 100% equity financed with a total market value of R450 000, consisting of ordinary shares trading at R5 each. Xelo Ltd pays all its net income as dividends and is in a 15% tax bracket. The firm is considering using one of the following capital structures:
Debt ratio
Before-tax cost of debt (kd)
Required
30%
4%
17%
45%
7%
20%
REQUIRED
(a) Calculate the debt, equity and number of shares under each of the capital structures under consideration. [5]
(b) Calculate expected earnings per share (E/EPS) for the proposed capital structures. [7]
(c) Use the valuation model to estimate share value of both capital structures. [4]
(d) Based on the long-term and short-term goals of financial management, which capital structure would you recommend? [4]
(e) Based on the long-term goal, at what overall capitalisation rate would you capitalise the company and why? [5]

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