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Fundamentals of Financial Management

Essay by   •  September 21, 2017  •  Essay  •  2,159 Words (9 Pages)  •  980 Views

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(a)

company A

company B

1

Dividend per share (2016)

16.40

3.66

2

Earnings per share (2016)

32.80

12.20

3

Dividend cover ratio (1/2)

0.5

0.3

4

Retention ratio (1.00-3)

0.5

0.7

5

Return on equity

0.075

0.0585

6

Growth ratio (4×5)

0.0375

0.04095

7

Div1  [1×(1.00+6)]

17.015

3.81

8

Current share price

463.0

250.5

9

Cost of equity (7/8+6)

0.0742

0.05616

(b)

company A

company B

1

share price

4.63

2.505

2

No. of shares

326030000

715661000

3

market to book value

1.46

1.15

4

equity market value(1×2)

1509518900

1792730805

5

equity book value(4/3)

1033917055

1558896352

6

capital gearing

28.36%

56.21%

7

debt book value(5×6/(1-6))

409294914.5

2001040511

8

debt market value

409294914.5

2001040511

9

capital market value(4+8)

1918813814

3793771316

10

cost of debt

4%

4%

11

cost of equity

7.42%

5.62%

12

tax rate

19%

19%

13

the weight of equity of merged company(4/(9A+9B))

26.42%

47.25%

14

the weight of debt of merged company(8/(9A+9B))

7.16%

35.03%

15

the overall cost(10×14A×(1-12)+10×14B×(1-12)+11A×13A+11B×13B)

5.98%

(c)

company A

company B

the merged company

1

debt book value

409294914.5

2001040511

2

cost of debt

4%

4%

3

interest(1×2)

16371796.58

80041620.42

96413417

4

earnings per share

0.328

0.122

5

No. of shares

326030000

715661000

6

NI(4×5)

106937840

87310642

7

tax rate

19%

19%

8

EBT(6/(1-7))

132022024.7

107790916.0

239812940.7

9

EBIT(8+3)

148393821.3

187832536.5

336226357.7

10

the overall interest cover(9/3)

9.06

2.35

3.49

(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 company's 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 firm's 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 company's 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 company's 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.

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