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LEVERAGE AND RISK (12 marks) After the success of a new hotel at East London, Mr Danny Peez plans to build another hotel as well as a casino at an...

LEVERAGE AND RISK (12 marks)
After the success of a new hotel at East London, Mr Danny Peez plans to build another hotel as well as a casino at an exclusive location somewhere in Madrid. He has to make a decision on the capital structure of the project. The total asset value is R200 million and an estimated EBIT of R60 million will be generated. The tax rate is 30%. The balance in financing needed will be raised by issuing shares at R40 each under each of the following two capital structures which are being investigated:

Structure A B
Value of bonds R20 m R80m
Coupon rate of bonds 8% 10%
Value of preferred shares R40m R20m
Preferred dividend percentage 10% 8%
Shareholders’required rateofreturn 12% 15%

REQUIRED
(a) What is the estimated share value (end of year) under each alternative? (6)
(b) What is the financial breakeven point for each alternative? (Hint: this is where income is just sufficient to pay all costs) (2)
(c) Which level of EBIT will give the same EPS for both capital structures? (4)
LEVERAGE AND RISK (12 marks) After the success of a new hotel at East London, Mr Danny Peez plans to build another hotel as well as a casino at an exclusive location somewhere in Madrid. He has to make a decision on the capital structure of the project. The total asset value is R200 million and an estimated EBIT of R60 million will be generated. The tax rate is 30%. The balance in financing needed will be raised by issuing shares at R40 each under each of the following two capital structures which are being investigated: Structure A B Value of bonds R20 m R80m Coupon rate of bonds 8% 10% Value of preferred shares R40m R20m Preferred dividend percentage 10% 8% Shareholders’ required rate of return 12% 15% REQUIRED (a) What is the estimated share value (end of year) under each alternative? (6) (b) What is the financial breakeven point for each alternative? (Hint: this is where income is just sufficient to pay all costs) (2) (c) Which level of EBIT will give the same EPS for both capital structures? (4)
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