FIN4801
ASSIGNMENT 5 2024
UNIQUE NO.
DUE DATE: 2024
, lOMoARcPSD|21997160
Question 1 (40 Marks)
(Capital structure decision making, learning units 7, 13 and 14)
Read the following case and then answer the required section below the case:
Offices Ltd. is a construction company focused on office space, which in the past had a large
market capitalisation and turnover, but, after the recent pandemic, finds itself struggling to
recover to its past stature in the construction industry due to the lower demand for office space.
The company has, over the past few years sold off all its subdivisions and is now focussed
solely on its core competency of building offices.
Demand for new offices has remained subdued since 2020, however, there is still enough
demand for the company to stay afloat. The management of Offices Ltd (from hereon,
management) believes that the company can operate in this environment and return healthy
profits due to its experienced staff. Management believes in the turnaround plan and the
prospects of the company and is sure that it will return to being a large competitor in its
industry, however, it is not expected that the company will return to its size pre the pandemic.
Due to low demand, the company is cash poor and management wishes to raise more funds
to implement the proposed turn-around plan, which is based around reducing debt repayments
(lowering financial leverage) and focusing on their core competency.
Below follows some financial information regarding the company:
• Current number of shares in issue: 200 000 000
• Current share price: 30c
• Current capital structure: Assets = R200 000 000; Liabilities= R100 000 000; Equity =
R100 000 000
• Current EBIT (operating profit) = R20 000 000
• Current interest expense = R12 000 000
• Tax rate: 27%
• Current beta: 1.9
• Risk free rate: 8%
• Market risk premium: 5%
The company has had to incur a lot of debt to stay afloat and is planning a rights issue to raise
funds to repay some of its debts and to implement its turn-around plan. Management estimates
that it needs R20 000 000 over and above any retained earnings to implement the turnaround
plan while they wish to lower its debt by R50 000 000 to bring about better profitability due to
reduced interest payments, together with more future flexibility. It is not expected that EBIT
would change for the foreseeable future and that any effect of the turn-around plan would only
be felt later. The company will, immediately, use R50 000 000 to retire debt to that amount,
while the R20 000 000 for the turn-around plan would be kept as cash initially. The interest
payment is expected to fall in line (proportionally) with the reduction in the amount of debt.
Required:
a.) If a company changes its capital structure, what do you expect would happen to its risk
profile and the return it is expected to generate. (8 Marks)
2
ASSIGNMENT 5 2024
UNIQUE NO.
DUE DATE: 2024
, lOMoARcPSD|21997160
Question 1 (40 Marks)
(Capital structure decision making, learning units 7, 13 and 14)
Read the following case and then answer the required section below the case:
Offices Ltd. is a construction company focused on office space, which in the past had a large
market capitalisation and turnover, but, after the recent pandemic, finds itself struggling to
recover to its past stature in the construction industry due to the lower demand for office space.
The company has, over the past few years sold off all its subdivisions and is now focussed
solely on its core competency of building offices.
Demand for new offices has remained subdued since 2020, however, there is still enough
demand for the company to stay afloat. The management of Offices Ltd (from hereon,
management) believes that the company can operate in this environment and return healthy
profits due to its experienced staff. Management believes in the turnaround plan and the
prospects of the company and is sure that it will return to being a large competitor in its
industry, however, it is not expected that the company will return to its size pre the pandemic.
Due to low demand, the company is cash poor and management wishes to raise more funds
to implement the proposed turn-around plan, which is based around reducing debt repayments
(lowering financial leverage) and focusing on their core competency.
Below follows some financial information regarding the company:
• Current number of shares in issue: 200 000 000
• Current share price: 30c
• Current capital structure: Assets = R200 000 000; Liabilities= R100 000 000; Equity =
R100 000 000
• Current EBIT (operating profit) = R20 000 000
• Current interest expense = R12 000 000
• Tax rate: 27%
• Current beta: 1.9
• Risk free rate: 8%
• Market risk premium: 5%
The company has had to incur a lot of debt to stay afloat and is planning a rights issue to raise
funds to repay some of its debts and to implement its turn-around plan. Management estimates
that it needs R20 000 000 over and above any retained earnings to implement the turnaround
plan while they wish to lower its debt by R50 000 000 to bring about better profitability due to
reduced interest payments, together with more future flexibility. It is not expected that EBIT
would change for the foreseeable future and that any effect of the turn-around plan would only
be felt later. The company will, immediately, use R50 000 000 to retire debt to that amount,
while the R20 000 000 for the turn-around plan would be kept as cash initially. The interest
payment is expected to fall in line (proportionally) with the reduction in the amount of debt.
Required:
a.) If a company changes its capital structure, what do you expect would happen to its risk
profile and the return it is expected to generate. (8 Marks)
2
