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The business plan indicates that the firm requires $50 million to purchase initial buildings and equipment and is expected to generate annual net...
The business plan indicates that the firm requires $50 million to purchase initial buildings and equipment and is expected to generate annual net operating cash flow of $10 million in perpetuity. Three alternative financing plans are being considered: Scenario 1: equity of $50 million; Scenario 2: equity of $25 million and bank loan of $25 million at an interest rate of 6% per annum; Scenario 3: equity of $35 million and bank loan of $15 million at an interest rate of 14% per annum. a) Assuming no taxes for each of the scenarios above, you are required to calculate return to equity holders and weighted average cost of capital. Also, together with gearing ratios, you need to interpret these results on the basis of the Modigliani and Miller's propositions on a firm's capital structure. b) Justify why it is necessary to assume 'a world without taxes' under MM proposition pertaining to a firm's capital structure. c) How will your results differ if you apply 30% corporate tax rate? Show all calculations.
