Manny Co is a listed company that plans to spend K10m onexpanding its existing business. It has been suggested that themoney could be raised by issuing 9% loan notes redeemable in tenyears’ time. Current financial information on Manny Co is asfollows.
Income statement information for the last year
                                                                                                                       K000
Profit before interest and tax                                                                           7,000
Interest                                                                                                            (500)
Profit before tax                                                                                             6,500
Tax                                                                                                                (1,950)
Profit for the period                                                                                         4,550
Balance sheet for the last year                                                K000              K000
Non-current assets                                                                                         20,000
Current assets                                                                                                20,000
Total assets                                                                                                   40,000
Equity and liabilities
Ordinary shares, par value K1Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 5,000
Retained earnings                                                                   22,500
Total equity                                                                                                    27,500
10% loan notes                                                                                   5,000
9% preference shares, par value K1Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 2,500
Total non-current liabilities                                                                              7,500
Current liabilities                                                                                             5,000
Total equity and liabilities                                                                                40,000
The current ex div ordinary share price is K4.50 per share. Anordinary dividend of 35 cents per share has just been paid anddividends are expected to increase by 4% per year for theforeseeable future. The current ex div preference share price is76.2 cents. The loan notes are secured on the existing non-currentassets of Manny Co and are redeemable at par in eight years’ time.They have a current ex interest market price of K105 per K100 loannote. Manny Co pays tax on profits at an annual rate of 30%.
The expansion of business is expected to increase profit beforeinterest and tax by 12% in the first year. Manny Co has nooverdraft.
Average sector ratios:
Financial gearing: 45% (prior charge capital divided by equitycapital on a book value basis)
Interest coverage ratio: 12 times
Required:
(a) Calculate the current weighted average cost ofcapital of Manny Co.
(b) Discuss whether financial management theory suggeststhat Manny Co can reduce its weighted average cost of capital to aminimum level.
(c) Evaluate and comment on the effects, after one year,of the loan note issue and the expansion of business on thefollowing ratios:
(i) Interest coverage ratio;
(ii) Financial gearing;
(iii) Earnings per share.
Assume that the dividend growth rate of 4% isunchanged.
