MAC3702 Mock Exam (October/November) 2023 100% TRUSTED workings, explanations and solutions. For assistance call or us on +/ 2/ 5/ 4 /7 /7 /9 /5 /4 /0 /1 /3 /2 .
QUESTION 1 (25 marks; 30 minutes)
MusclePharm Ltd (MusclePharm) was founded in 2005 to develop the most scientifically
advanced, cl...
MusclePharm Ltd (MusclePharm) was founded in 2005 to develop the most scientifically
advanced, clinically aligned and safest range of dietary supplementation possible. MusclePharm
is currently financed by a debt to equity ratio of 20 : 80.
Management of MusclePharm is considering investing in a new product line, namely BizzyDiet,
that specialises in the development of beverages and health bars. The company is considering
five possible capital structures for the new investment. The financial manager, Mr Ezempilo, has
done some research and analysed the capital structures of comparable companies with
equivalent business risks as follows:
1. The company has a tax rate of 28%.
2. MusclePharm will generate steady earnings before interest and tax (EBIT) of R13 125
million per annum for the foreseeable future.
3. The pre-tax cost of debt will remain constant, irrespective of the capital structure, at a
cost of 11,67%. However, the cost of equity will fluctuate at the different gearing ratios.
The table below sets out these fluctuating costs:
Gearing ratio Cost of equity capital
(Debt capital/Total capital)
4. The cost of the investment in BizzyDiet amounts to R25 million and it will be financed through
equity and debt using the optimal capital structure. The current share price of MusclePharm
was determined at R44 per share. There are one million shares in issue.
1
, Mock Exam MAC3702
October/November 2023
QUESTION 1 (Continued)
REQUIRED:
(a) Calculate the effective after-tax weighted average cost of capital (WACC) and the total
market value of capital employed for each of the five possible capital structures and
recommend to management of MusclePharm what the optimal capital structure is based
on the results of your calculation. (13 marks)
(b) Calculate the new investment and advise management on how it should be financed.
(7 marks)
(c) Indicate, based on the assumptions that there are no taxes, cost of financial distress, or
agency cost, why the market value of the company is not affected by the capital structure
of the company (2 marks)
(d) Discuss three of the Miller and Modigliani theory assumptions not mentioned in (a) above.
(3 marks)
[25 marks]
2
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