Question

1 )The following table shows type of franking credit and amount of dividend for two companies. Your task is to calculate the amount of franking credit and price per share on ex-dividend date. Show your workings by writing down the formula where appropriate.

Name	Company X	Company Y
Franking Credits	Fully Valued	No value
Current Share Price	$30	$25
Dividend per share announced	$1	$1.50
Tax rate	30%	30%
Franking Credit	?	?
Share Price on Ex-Dividend Date	?	?

2) The manager of Dynamix Corporation is planning to investment in a factory that will produce X-ray machines. The cost of the project will be around $20 Million. The manager has the following options to raise funding for the factory. Your task is to explain clearly how the manager will go about choosing the funding source. Explain your answer in detail.

Funding Source	$(Million )
Issuing Shares	50
Retained Earnings	10
Bank Loan	30

3) From the figures outlined in the table below for fossom foods, calculate the Weighted Average Cost of Capital (WACC).

Cost of debt capital	0.10
Corporate tax rate	0.30
Market value of debt	$20 000 000
Cost of equity capital	0.20
Market value of fossom foods	$40 000 000

Answer 1

1.A franked dividend is an arrangement in Australia that eliminates the double taxation of dividends. The shareholder is able to reduce the tax paid on the dividend by an amount equal to the tax imputation credits.

Franked dividends eliminate this double taxation by giving investors a tax credit, commonly known as franking credit, for the amount of tax the business paid on that dividend.

(i) Company X = Franking credit = (Dividend Amount ÷ (1 - Company Tax rate)) - Dividend Amount

= (1 /(1-0.3))-1

=0.43 per share

Share price on Ex dividend rate = Market price - Dividend = 30-1 = $29.

Here, The shareholder would receive a fully franked dividend of $1 per share and their dividend statement would show a franking credit of $0.43 per share. It means though the taxabe income will be 1 per share tax payment will be zero as they can use the franking credit.

(ii) Company Y

No value means unfrances . It means no tax has been paid by the company and the tax burden wil be on the share holder.

Franking credit = 0

Share price on Ex dividend rate = Market price - Dividend = 25-1.5 = $23.5.

Here,The sharehoders taxable income wil be $ 1.5 per share and tax payable will be 30% of 1.5 = 0.45

2.

The cost of the project will be around $20 milion.

(i) Retained earnings of $ 10million can be used as retained earnings is a permanent source of funds available to an organisation and It does not involve any explicit cost in the form of interest, dividend or floatation cost. As the funds are generated internally, there is a greater degree of operational freedom and flexibility.It may also lead to increase in the market price of the equity shares of a company.

(ii) Additional 10million can be raised from bank as a loan.Loan from a bank is a flexible source of finance as the loan amount can be increased according to business needs and can be repaid in advance when funds are not needed and as far as companies are concerned, debt capital is a potentially attractive source of finance because interest charges reduce the profits chargeable to corporation tax.

Though Equity capital can be repaid only at the time of liquidation of a company and Payment of dividend to the equity shareholders is not compulsory but

(a)The cost of equity shares is generally more as compared to the cost of raising funds through other sources

(b)Issue of additional equity shares dilutes the voting power, and earnings of existing equity shareholders

(c)More formalities and procedural delays are involved while raising funds through issue of equity share

3.

wieghted average cost of capital = (weight of equity * cost of equity )+((weight of debt*cost of debt)*(1-tax rate))

weight of equity = equity / equity+debt = 40,000,000/60,000,000 = 0.67

weight of debt = 20,000,000/60,000,000 = 0.33

WACC = (0.67*0.2)+((0.33*0.1)*(1-0.3))= 0.134+0.0231 = 0.1571 = 15.71%