1

Chapter 12
Funding the Business
Answer to End of Chapter Exercises

Q 12.1
Cost of debt 1,000,000 of debt at 8% = 80,000.
Interest = 80,000 x ( 1-0.35) = 52,000

'52,000 = 4.33%
1,200,000

Cost of equity
dividend = 6.67%
Market price

Weighted average cost of capital

Source
of Market Proportion Cost of Weighted average
finance value Capital
Equity 3,000,000 71.43% 6.67% 4.8%
Debt 1,200,000 28.57% 4.33% 1.2%
6.0%

Q 12.2
Cost of debt
1,500,000 of debt at 6% = 90,000.
interest=90,000 x ( 1-0.3) =63,000

63,000 = 4.50%
1,400,000
Cost of
equity
dividend = 7.50%
market price

Weighted average cost of capital

Source
of Market Proportion Cost of Weighted average
finance value Capital
Equity 6,000,000 81.08% 7.50% = 6.08%
Debt 1,400,000 18.92% 4.50% = 0.85%
= 6.93%

2008 John Wiley & Sons Ltd.

www.wileyeurope.com/college/bowhill
 2

Q 12.3 a. Interest saved=

i) 300,000 x 60% = 78,000
If pay 1 month earlier then the interest paid is 12%/12 = 1%. The interest paid
is therefore 78,000 x 1% = 780
ii) 25,000 x 40% = 10,000
If pay 2 months earlier then the interest paid is 12%/12 x 2 = 2%. The interest
paid is therefore 10,000 x 2% = 200

Total interest saved therefore = 780 + 200 = 980

b. Loss of discount =
i) 78,000 x 2% = 1,560
ii) 10,000 x 2% = 200

Total cost = 1,560 + 200 = 1,760

c. The net impact of offering the discount is a reduction on profit of 1,760 - 980
= 780

Q 12.4 The cost saving is 4000 x 2.5% = 100 a month

Interest lost if pay one month quicker is 4000 x 15%/12 = 50 a month.
Therefore the discount is worthwhile as long as CD Ltd is not paying more than two months
earlier than before.

Q 12.5 The following points could be discussed:

- The need to match cash flows. A loan will require capital repayments and if the
cash flows from the business are inadequate, share capital may be a better option.
- Consider the impact of the investment on the key ratios discussed in chapter 11
given the different form of funding.
- It is necessary to confirm that the interest on any additional loans will be tax
deductible i.e. the business has not used up the tax shield.
- Issuing additional share capital will impact on ownership.
- Impact on cost of capital (if any) might be considered.
- Risks involved in the investments. High risk investments can indicate the need for
less risky investments.

2008 John Wiley & Sons Ltd.

www.wileyeurope.com/college/bowhill