Imperial Sandwich Plc is to be established shortly. The founders are considering their options with regard to capital structure. A total of £5 m will be required to establish the business and the two steps of raising these funds being considered here are:
a) Selling 1 million shares at £5.00
b) Selling 500,000 shares at £5.00 and borrowing £2.5 million with an interest rate of 10%.
The company strategy to pay out the total net income as dividends to the shareholders. The possible outcome for the future EBIT is £750,000. The corporate tax rate is 40%.
The founders has examined a proxy company and found it to have a beta of 1.2 and a market debt-equity ratio of 0.5. The risk-free rate is 5.8% and the market premium 4.5%
a) Calculate the WACC under every of the capital structures. Comment on the result.