Corporate Finance of Altium Limited

Question: Discus about the Corporate Finance of Altium Limited. Answer: Introduction:- The capital structure describes the different sources of finances, used by the business firms to continue its operating activities and non-operating activities, as well. It explains how any firm finances its business activities to generate revenues and ensure the organizational growth in future. The two most important components of any firms capital structure are equity financing and debt financing (Saunders Cornett, 2014). It is very necessary for any firm to construct a proper capital structure for funding the capital. There are many factors, which are significantly considered for constructing a proper and useful capital structure. The cost of capital is one of the influential factors, which helps the firms to determine the effective capital structure (Zeitun Tian, 2014). The firm always intends to raise its capital from such sources, which would cost lesser than the return from the operational activities. If the cost of capital would become higher than the returns, then the firm uses to face several financial issues. Due to high cost of debt capital, the interest expenses would increase and the net profit would fall down accordingly. On the other hand, if any firm cannot provide higher return on capital than the cost of equity capital, then the equity investors would not invest in such firms further and the firm would face problem to raise capital through equity financing (Bodie et al., 2014). Hence, it is important to consider the cost of capital for maintaining an optimum capital structure. There are many theories, which explain the impact of cost of capital on the capital structure of any firm. However, amongst all the theories, Modigliani-Miller theorem (MM theorem) is the most popular and revered theory in this respect. It defines how the firm should evaluate the cost of capital for constructing an optimum capital structure. In this report, the cost of capital of Altium Limited is evaluated under proper method to describe its relationship with the capital structure of company in accordance to the MM theorem. Concept of Modigliani-Miller Theorem:- According to the theory of Modigliani and Miller, in the efficient capital market, if there are no tax charges, bankruptcy costs or agency fees and any asymmetric information is not available, then the sources of financing any firm do not affect the value of the firm. The theory has focused on the following assumptions to derive the mentioned outcome: There is no transaction cost The interest rate on debts are same for the individuals and the business firms On the basis of the stated assumptions, MM theorem suggests that the value of any levered firm would be equal to the value of unlevered firm (Charness Neugebauer, 2015). The equation is shown below: VU = VL It indicates that the purchase price of any firm with only equity capital will be same as the purchase price of a firm, which includes both debt and equity capital. However, the theory was developed by assuming that the business world is tax free, which is not feasible in real world. Hence, amongst all the other costs, the tax charges are taken into consideration for incorporating more practical approach in the theory and making it useful for the actual business world. The modification is included in MM theory as Proposition II, while the earlier concept is referred as Proposition I. In the Proposition II of MM theorem, the value of the levered firm is computed by using the following equation: RE = RO + D/E [ (RO RD) x (1 TC)] Where, RE = Cost of levered equity RO = Cost of unlevered equity RD = Cost of Debt TC = Tax Rate This modified version of MM theory explains that the value of any levered firm will be the total of unlevered cost of equity and financing premium. The financing premium is the proportionate cost of unlevered equity over the cost of debt after deducting the tax on cost of debt (Aboura Lepinette, 2015). It can be stated from the above equation that the business firms can lower down its weighted average cost of capital by funding the finance with higher amount of cheaper debt capital instead of equity capital. It denotes that the companies with higher gearing ratios can enjoy relatively lower cost of capital. Based on this concept, the theory states that any firm can achieve the optimal capital structure, where the cost of capital will be lowest, if it raises its capital through 100% debt capital (Gersbach et al., 2015). Calculation of Weightage Average Cost of Capital:- The capital structure of Altium Limited is evaluated through the concept of MM theorem. For the evaluation, it is necessary to compute the weighted average cost of capital of the company. As the company pays tax as per the general norms, the equation, stated as Proposition II should be applied for deriving the cost. Cost of Equity Capital:- Amongst the three components, cost of debt, gearing ratio and income tax rates can be assessed from the annual reports of the company. However, for the cost of unlevered equity capital, various researchers suggest different techniques and concepts. Some of the scholars consider return on equity or current dividend yield rate as cost of capital. However, the most appropriate and widely accepted method for computing the cost of equity capital is the Capital Asset Pricing Model (CAPM). In this method, the cost of equity is computed as per the market value of the company stocks and its volatility level in respect to the overall market indices (Cenesizoglu et al., 2016). The formula of cost of equity capital under this method is as follows: RE = Rf + (Rm - Rf) Where, RE = Cost of Equity Capital Rf = Risk Free Return (mainly Coupon Rate of 10 yrs. Government Bonds) Rm= Market Return Rate ( Return Rate of Certified Stock Index) = Beta or the Volatility Level of the Stock in accordance to the related Stock Index (Vollmer, 2014). The cost of equity capital of Altium Limited is computed under the CAPM Model in the following table: Altium Ltd. ASX 200 Date Adj Closing Price Daily Return Adj Closing Price Daily Return 7/1/2015 4.06449 5515.700195 7/2/2015 4.24492 4.44% 5599.799805 1.52% 7/3/2015 4.15945 -2.01% 5538.299805 -1.10% 7/6/2015 4.05499 -2.51% 5475 -1.14% 7/7/2015 4.25441 4.92% 5581.399902 1.94% 7/8/2015 4.3019 1.12% 5469.5 -2.00% 7/9/2015 3.88405 -9.71% 5471 0.03% 7/10/2015 4.08348 5.13% 5492 0.38% 7/13/2015 4.13096 1.16% 5473.200195 -0.34% 7/14/2015 4.13096 0.00% 5577.399902 1.90% 7/15/2015 4.00751 -2.99% 5636.200195 1.05% 7/16/2015 4.017 0.24% 5669.600098 0.59% 7/17/2015 3.99801 -0.47% 5670.100098 0.01% 7/20/2015 4.07398 1.90% 5686.899902 0.30% 7/21/2015 4.05499 -0.47% 5706.700195 0.35% 7/22/2015 4.10247 1.17% 5614.600098 -1.61% 7/23/2015 4.00751 -2.31% 5590.299805 -0.43% 7/24/2015 3.95053 -1.42% 5566.100098 -0.43% 7/27/2015 3.99801 1.20% 5589.899902 0.43% 7/28/2015 3.97902 -0.47% 5584.700195 -0.09% 7/29/2015 4.0265 1.19% 5624.200195 0.71% 7/30/2015 4.17844 3.77% 5669.5 0.81% 7/31/2015 4.27341 2.27% 5699.200195 0.52% 8/3/2015 4.13096 -3.33% 5679.299805 -0.35% 8/4/2015 4.14995 0.46% 5697.899902 0.33% 8/5/2015 4.13096 -0.46% 5674 -0.42% 8/6/2015 4.06449 -1.61% 5610.100098 -1.13% 8/7/2015 4.06449 0.00% 5474.799805 -2.41% 8/10/2015 4.06449 0.00% 5509.200195 0.63% 8/11/2015 3.96952 -2.34% 5473.200195 -0.65% 8/12/2015 3.86506 -2.63% 5382.100098 -1.66% 8/13/2015 3.89355 0.74% 5387.899902 0.11% 8/14/2015 3.99801 2.68% 5356.5 -0.58% 8/17/2015 4.036 0.95% 5367.700195 0.21% 8/18/2015 4.09297 1.41% 5303.100098 -1.20% 8/19/2015 3.93154 -3.94% 5380.200195 1.45% 8/20/2015 3.87456 -1.45% 5288.600098 -1.70% 8/21/2015 3.7606 -2.94% 5214.600098 -1.40% 8/24/2015 3.52319 -6.31% 5001.299805 -4.09% 8/25/2015 3.70362 5.12% 5137.299805 2.72% 8/26/2015 3.79858 2.56% 5172.799805 0.69% 8/27/2015 3.84607 1.25% 5233.299805 1.17% 8/28/2015 3.89355 1.23% 5263.600098 0.58% 8/31/2015 3.85556 -0.98% 5207 -1.08% 9/1/2015 3.77959 -1.97% 5096.399902 -2.12% 9/2/2015 3.87456 2.51% 5101.5 0.10% 9/3/2015 3.87456 0.00% 5027.799805 -1.44% 9/4/2015 4.06449 4.90% 5040.600098 0.25% 9/7/2015 4.10247 0.93% 5030.399902 -0.20% 9/8/2015 4.08348 -0.46% 5115.200195 1.69% 9/9/2015 4.14995 1.63% 5221.100098 2.07% 9/10/2015 4.15945 0.23% 5095 -2.42% 9/11/2015 4.18794 0.68% 5071.100098 -0.47% 9/14/2015 4.2924 2.49% 5096.5 0.50% 9/15/2015 4.27341 -0.44% 5018.399902 -1.53% 9/16/2015 4.35888 2.00% 5098.899902 1.60% 9/17/2015 4.33039 -0.65% 5146.799805 0.94% 9/18/2015 4.14046 -4.39% 5170.5 0.46% 9/21/2015 4.22593 2.06% 5066.200195 -2.02% 9/22/2015 4.17844 -1.12% 5103.600098 0.74% 9/23/2015 4.18812 0.23% 4998.100098 -2.07% 9/24/2015 4.29451 2.54% 5071.700195 1.47% 9/25/2015 4.39123 2.25% 5042.100098 -0.58% 9/28/2015 4.41058 0.44% 5113.5 1.42% 9/29/2015 4.38156 -0.66% 4918.399902 -3.82% 9/30/2015 4.45894 1.77% 5021.600098 2.10% 10/1/2015 4.60403 3.25% 5112.100098 1.80% 10/2/2015 4.60403 0.00% 5052 -1.18% 10/5/2015 4.66206 1.26% 5150.5 1.95% 10/6/2015 4.54599 -2.49% 5167.399902 0.33% 10/7/2015 4.5073 -0.85% 5197.899902 0.59% 10/8/2015 4.45894 -1.07% 5210.399902 0.24% 10/9/2015 4.51697 1.30% 5279.700195 1.33% 10/12/2015 4.44927 -1.50% 5232.899902 -0.89% 10/13/2015 4.4396 -0.22% 5202.899902 -0.57% 10/14/2015 4.42992 -0.22% 5197.299805 -0.11% 10/15/2015 4.24615 -4.15% 5230 0.63% 10/16/2015 4.29451 1.14% 5268.200195 0.73% 10/19/2015 4.25582 -0.90% 5269.700195 0.03% 10/20/2015 4.24615 -0.23% 5235.600098 -0.65% 10/21/2015 4.25582 0.23% 5248.299805 0.24% 10/22/2015 4.13975 -2.73% 5263.799805 0.30% 10/23/2015 4.23648 2.34% 5351.600098 1.67% 10/26/2015 4.2268 -0.23% 5348 -0.07% 10/27/2015 4.17844 -1.14% 5346.200195 -0.03% 10/28/2015 4.42992 6.02% 5335.200195 -0.21% 10/29/2015 4.36222 -1.53% 5266.899902 -1.28% 10/30/2015 4.35255 -0.22% 5239.399902 -0.52% 11/2/2015 4.53632 4.22% 5165.799805 -1.40% 11/3/2015 4.6137 1.71% 5239.200195 1.42% 11/4/2015 4.58468 -0.63% 5242.299805 0.06% 11/5/2015 4.57501 -0.21% 5193 -0.94% 11/6/2015 4.51697 -1.27% 5215 0.42% 11/9/2015 4.46861 -1.07% 5119.5 -1.83% 11/10/2015 4.41058 -1.30% 5099.200195 -0.40% 11/11/2015 4.52665 2.63% 5122.600098 0.46% 11/12/2015 4.5073 -0.43% 5125.700195 0.06% 11/13/2015 4.46861 -0.86% 5051.299805 -1.45% 11/16/2015 4.6137 3.25% 5003.799805 -0.94% 11/17/2015 4.6137 0.00% 5118.200195 2.29% 11/18/2015 4.46861 -3.14% 5133.100098 0.29% 11/19/2015 4.6137 3.25% 5242.600098 2.13% 11/20/2015 4.72977 2.52% 5256.100098 0.26% 11/23/2015 4.67173 -1.23% 5276.399902 0.39% 11/24/2015 4.66206 -0.21% 5226.399902 -0.95% 11/25/2015 4.67173 0.21% 5193.700195 -0.63% 11/26/2015 4.74911 1.66% 5210.700195 0.33% 11/27/2015 4.71042 -0.81% 5202.600098 -0.16% 11/30/2015 4.74911 0.82% 5166.5 -0.69% 12/1/2015 4.84583 2.04% 5266.100098 1.93% 12/2/2015 4.79747 -1.00% 5258.299805 -0.15% 12/3/2015 4.79747 0.00% 5227.700195 -0.58% 12/4/2015 4.69108 -2.22% 5151.600098 -1.46% 12/7/2015 4.65239 -0.82% 5155.700195 0.08% 12/8/2015 4.70075 1.04% 5108.600098 -0.91% 12/9/2015 4.7878 1.85% 5080.5 -0.55% 12/10/2015 4.57501 -4.44% 5037.700195 -0.84% 12/11/2015 4.65239 1.69% 5029.5 -0.16% 12/14/2015 4.62337 -0.62% 4928.600098 -2.01% 12/15/2015 4.57501 -1.05% 4909.600098 -0.39% 12/16/2015 4.60403 0.63% 5028.399902 2.42% 12/17/2015 4.69108 1.89% 5102 1.46% 12/18/2015 4.73944 1.03% 5106.700195 0.09% 12/21/2015 4.72009 -0.41% 5109 0.05% 12/22/2015 4.69108 -0.61% 5116.700195 0.15% 12/23/2015 4.55566 -2.89% 5141.799805 0.49% 12/24/2015 4.47829 -1.70% 5207.600098 1.28% 12/29/2015 4.52665 1.08% 5267.299805 1.15% 12/30/2015 4.56534 0.85% 5319.899902 1.00% 12/31/2015 4.51697 -1.06% 5295.899902 -0.45% 1/4/2016 4.48796 -0.64% 5270.5 -0.48% 1/5/2016 4.46861 -0.43% 5184.399902 -1.63% 1/6/2016 4.41058 -1.30% 5123.100098 -1.18% 1/7/2016 4.30418 -2.41% 5010.299805 -2.20% 1/8/2016 4.27517 -0.67% 4990.799805 -0.39% 1/11/2016 4.31386 0.90% 4932.200195 -1.17% 1/12/2016 4.44927 3.14% 4925.100098 -0.14% 1/13/2016 4.47829 0.65% 4987.399902 1.26% 1/14/2016 4.39123 -1.94% 4909.399902 -1.56% 1/15/2016 4.32353 -1.54% 4892.799805 -0.34% 1/18/2016 4.34287 0.45% 4858.700195 -0.70% 1/19/2016 4.27517 -1.56% 4903.100098 0.91% 1/20/2016 4.42025 3.39% 4841.5 -1.26% 1/21/2016 4.44927 0.66% 4864 0.46% 1/22/2016 4.57501 2.83% 4916 1.07% 1/25/2016 4.67173 2.11% 5006.600098 1.84% 1/27/2016 4.76845 2.07% 4946.399902 -1.20% 1/28/2016 4.75878 -0.20% 4976.200195 0.60% 1/29/2016 4.75878 0.00% 5005.5 0.59% 2/1/2016 4.76845 0.20% 5043.600098 0.76% 2/2/2016 5.34879 12.17% 4993.299805 -1.00% 2/3/2016 5.18436 -3.07% 4876.799805 -2.33% 2/4/2016 5.08764 -1.87% 4980.399902 2.12% 2/5/2016 5.31978 4.56% 4976.200195 -0.08% 2/8/2016 5.26174 -1.09% 4975.399902 -0.02% 2/9/2016 5.01994 -4.60% 4832.100098 -2.88% 2/10/2016 5.07797 1.16% 4775.700195 -1.17% 2/11/2016 5.22305 2.86% 4821.100098 0.95% 2/12/2016 5.10699 -2.22% 4765.299805 -1.16% 2/15/2016 5.40683 5.87% 4843.5 1.64% 2/16/2016 5.56159 2.86% 4910 1.37% 2/17/2016 5.25207 -5.57% 4882.100098 -0.57% 2/18/2016 5.4165 3.13% 4992 2.25% 2/19/2016 5.49388 1.43% 4952.799805 -0.79% 2/22/2016 5.60995 2.11% 5001.200195 0.98% 2/23/2016 5.51322 -1.72% 4979.600098 -0.43% 2/24/2016 5.51322 0.00% 4875 -2.10% 2/25/2016 5.49388 -0.35% 4881.200195 0.13% 2/26/2016 5.31978 -3.17% 4880 -0.02% 2/29/2016 5.42617 2.00% 4880.899902 0.02% 3/1/2016 5.45519 0.53% 4922.299805 0.85% 3/2/2016 5.38748 -1.24% 5021.200195 2.01% 3/3/2016 5.51322 2.33% 5081.100098 1.19% 3/4/2016 5.54224 0.53% 5090 0.18% 3/7/2016 5.45519 -1.57% 5142.799805 1.04% 3/8/2016 5.2424 -3.90% 5108 -0.68% 3/9/2016 5.18436 -1.11% 5157.200195 0.96% 3/10/2016 5.39716 4.10% 5150.100098 -0.14% 3/11/2016 5.42617 0.54% 5166.399902 0.32% 3/14/2016 5.42617 0.00% 5185.5 0.37% 3/15/2016 5.29815 -2.36% 5111.399902 -1.43% 3/16/2016 5.49511 3.72% 5119 0.15% 3/17/2016 5.47541 -0.36% 5168.200195 0.96% 3/18/2016 5.52465 0.90% 5183.100098 0.29% 3/21/2016 5.49511 -0.53% 5166.600098 -0.32% 3/22/2016 5.50496 0.18% 5166.600098 0.00% 3/23/2016 5.73146 4.11% 5142.299805 -0.47% 3/24/2016 5.72161 -0.17% 5084.200195 -1.13% 3/29/2016 5.72161 0.00% 5004.5 -1.57% 3/30/2016 5.69207 -0.52% 5010.299805 0.12% 3/31/2016 5.81024 2.08% 5082.799805 1.45% 4/1/2016 5.761 -0.85% 4999.399902 -1.64% 4/4/2016 5.86933 1.88% 4995.299805 -0.08% 4/5/2016 5.87917 0.17% 4924.399902 -1.42% 4/6/2016 6.15491 4.69% 4945.899902 0.44% 4/7/2016 6.13522 -0.32% 4964.100098 0.37% 4/8/2016 5.96781 -2.73% 4937.600098 -0.53% 4/11/2016 5.9875 0.33% 4931.5 -0.12% 4/12/2016 6.08598 1.64% 4975.600098 0.89% 4/13/2016 6.15491 1.13% 5054.700195 1.59% 4/14/2016 6.16476 0.16% 5118.600098 1.26% 4/15/2016 6.15491 -0.16% 5157.5 0.76% 4/18/2016 6.10568 -0.80% 5137.100098 -0.40% 4/19/2016 6.20415 1.61% 5188.799805 1.01% 4/20/2016 6.214 0.16% 5216 0.52% 4/21/2016 6.22385 0.16% 5272.700195 1.09% 4/22/2016 6.14507 -1.27% 5236.399902 -0.69% 4/26/2016 6.12537 -0.32% 5220.600098 -0.30% 4/27/2016 6.15491 0.48% 5187.700195 -0.63% 4/28/2016 6.10568 -0.80% 5225.399902 0.73% 4/29/2016 6.05644 -0.81% 5252.200195 0.51% 5/2/2016 6.06628 0.16% 5243 -0.18% 5/3/2016 6.18446 1.95% 5353.799805 2.11% 5/4/2016 6.37157 3.03% 5271.100098 -1.54% 5/5/2016 6.36172 -0.15% 5279.100098 0.15% 5/6/2016 6.47005 1.70% 5292 0.24% 5/9/2016 6.47005 0.00% 5320.700195 0.54% 5/10/2016 6.24355 -3.50% 5342.799805 0.42% 5/11/2016 6.41096 2.68% 5372.299805 0.55% 5/12/2016 6.34202 -1.08% 5359.299805 -0.24% 5/13/2016 6.37157 0.47% 5329 -0.57% 5/16/2016 6.22385 -2.32% 5358.899902 0.56% 5/17/2016 6.25339 0.47% 5395.899902 0.69% 5/18/2016 5.97765 -4.41% 5356.200195 -0.74% 5/19/2016 5.94811 -0.49% 5323.299805 -0.61% 5/20/2016 5.96781 0.33% 5351.299805 0.53% 5/23/2016 6.03674 1.16% 5318.899902 -0.61% 5/24/2016 6.05644 0.33% 5295.600098 -0.44% 5/25/2016 6.13522 1.30% 5372.5 1.45% 5/26/2016 6.30263 2.73% 5388.100098 0.29% 5/27/2016 6.34202 0.62% 5405.899902 0.33% 5/30/2016 6.32233 -0.31% 5408 0.04% 5/31/2016 6.31248 -0.16% 5378.600098 -0.54% 6/1/2016 6.32233 0.16% 5323.200195 -1.03% 6/2/2016 6.33218 0.16% 5278.899902 -0.83% 6/3/2016 6.36172 0.47% 5318.899902 0.76% 6/6/2016 6.27309 -1.39% 5360.399902 0.78% 6/7/2016 6.32233 0.78% 5371 0.20% 6/8/2016 6.32233 0.00% 5370 -0.02% 6/9/2016 6.2337 -1.40% 5361.899902 -0.15% 6/10/2016 6.16476 -1.11% 5312.600098 -0.92% 6/14/2016 6.02689 -2.24% 5203.299805 -2.06% 6/15/2016 5.92841 -1.63% 5147.100098 -1.08% 6/16/2016 5.93826 0.17% 5146 -0.02% 6/17/2016 5.91857 -0.33% 5162.700195 0.32% 6/20/2016 5.99735 1.33% 5256.799805 1.82% 6/21/2016 5.99735 0.00% 5274.399902 0.33% 6/22/2016 5.93826 -0.99% 5270.899902 -0.07% 6/23/2016 6.10568 2.82% 5280.700195 0.19% 6/24/2016 5.85948 -4.03% 5113.200195 -3.17% 6/27/2016 6.02689 2.86% 5137.200195 0.47% 6/28/2016 5.99735 -0.49% 5103.299805 -0.66% 6/29/2016 6.24355 4.11% 5142.399902 0.77% 6/30/2016 6.36172 1.89% 5233.399902 1.77% Risk-Free Return Rate 4.75% Market Return Rate 23.07% Beta 0.64 Unlevered Cost of Capital 16.42% Cost of Debt:- Any business firm has to bear several forms of liabilities and debts. However, it does not have to pay interest on every form of debts, such as, accounts payable, outstanding wages, employee benefit etc. As the weighted average cost of capital requires the cost of debt for a certain period, the method only incorporates such debts, for which the firm has to pay interests. Such debts are referred as interest-bearing debts. The business firms use to exhibit the amount of interest bearing debts in the annual reports along with the interest expenses, incurred for such debts. The annual report of Altium Limited shows that the company has incurred interest expenses only for the lease liabilities and hence, it is the only interest-bearing debt for the company in the current year ("Annual Report 2016", 2017). Gearing Ratio:- Gearing ratio defines the relationship between the total debt and total equity of the business firm. The formula of gearing ratio is as follows: Gearing Ratio: Total Debt / Total Equity The ratio is used to explain the capital structure of any firm. It describes, on which form of capital, the business firm is more depending to continue its operations. If the gearing ratio of any company is higher than 1, then it indicates that the firm has more debt capital than the equity capital and vice versa for a gearing ratio with lower than 1. Problems for Computing Gearing Ratio:- It is a very easy technique to ascertain the capital structure of any business. However, it has been observed that, in many cases, it cannot be derived so easily. The main issue, which makes it complicated, is the availability of the proper financial data. Moreover, the selection of debts for computing gearing ratio also becomes very tough due to the nature of the debts. In the weighted average cost of capital, the debts, which should be considered for computing the cost of capital, are the interest bearing debts. However, often the analysts use to include all the debts for computing gearing ratio instead of focusing only on the interest bearing debts. Therefore, it is necessary to understand the objective of the implication of gearing ratio and select the selct the debt item in accordance to the objective. Gearing Ratio of Altium Limited:- The gearing ratio of Altium Limited is required to compute the weighted average cost of capital. Hence, the gearing ratio should incorporate such debts, for which the company has to incur interest expenses or other debt related costs. The proper gearing ratio of Altium Limited is computed below: Computation of Gearing Ratio: Particulars Amount Equityholder's Fund 125177 Total Equity A 125177 Long-Term Debt 20 Current portion of long term Debt 51 Total Interest Bearing Debt B 71 Gearing Ratio C=B/A 0.06% Computation of Cost of Capital:- The cost of levered capital of Altium Limited is calculated in the following table as per the MM theorem:- Cost of Capital:- Particulars Amount Weightage Cost Weighted Average Cost Equityholder's Fund 125177 100% 16.42% 16.42% Total Equity 125177 100.00% 16.42% 16.42% Long-Term Debt 20 28.17% 35 49.30% Current portion of long term Debt 51 71.83% Total Debt 71 100.00% 49.30% 49.30% Gearing Ratio 0.06% Tax Rate 30% Cost of Capital 16.41% Capital Structure of Altium Limited:- The gearing ratio of Altium Limited, calculated in the table above, is minimal. The total liabilities, including interest-bearing and non-interest bearing debt capital, are also almost half of the total equity, including contributed share capital, reserves and retained earnings. Thus, it depicts that the company mainly depends on the equity capital instead of interest-bearing debt capital ("Annual Report 2016", 2017). Such capital structure may seem to be beneficial for the company, as it does not have to incur high interest expenses for the debt capitals. Due to absence of higher interest expenses, it can convert most of net operating income into the net earnings attributable to share holders. Thus, it can provide higher amount of dividends to the shareholders and increase the market value of the shares accordingly (Novak 2015). However, according to the MM theory, the present capital structure of Altium Limited is not an effective structure for the company. The cost of capital of the company is mostly comprised of the cost of equity capital, on which it cannot enjoy any tax deduction. It means that if the company pays higher dividend to its shareholders, then it will cause higher amount of cash outflow without any cash savings for tax benefits (Brusov et al., 2015). Conclusion Recommendations:- It is clear from the above discussions that Altium Limited maintains a very low gearing ratio. Therefore, the company does not have to bear any higher amount of fixed interest expenses on the debts. From this perspective, the present capital structure can be effective for the company. Modigliani-Miller theory does not support this fact. The theory explains that the cost of capital of the company is much higher due to lower gearing ratio. The company cannot enjoy the tax benefits from interest expenses and reduce the cash outflows. Altium Limited should finance its capital through interest bearing debts to increase the gearing ratio. As the result, it will help the company to reduce the weighted average cost of capital accordingly. However, the management of Altium Limited should take such debts, which will incur low interest expenses. If the interest rates will be higher than the cost of capital, then the company cannot enjoy the benefits of higher gearing ratio. Referencess ^AXJO: Summary for SP/ASX 200- Yahoo!7 Finance. (2017).Au.finance.yahoo.com. Retrieved 21 January 2017, from https://au.finance.yahoo.com/q?s=%5EAXJO Saunders, A., Cornett, M. M. (2014).Financial institutions management. McGraw-Hill Education, Zeitun, R., Tian, G.G., (2014). Capital structure and corporate performance: evidence from Jordan Bodie, Z., Kane, A., Marcus, A. J. (2014).Investments, 10e. McGraw-Hill Education Charness, G., Neugebauer, T. (2015). A test of the Modigliani-Miller invariance theorem and arbitrage in experimental asset markets Stulz, R. M. (2016). Risk management, governance, culture, and risk taking in banks. Brusov, P., Filatova, T., Orekhova, N., Eskindarov, M. (2015). Capital Structure: ModiglianiMiller Theory. InModern Corporate Finance, Investments and Taxation(pp. 9-25). Springer International Publishing. Gersbach, H., Haller, H., Mller, J. (2015). The macroeconomics of ModiglianiMiller.Journal of Economic Theory,157, 1081-1113. Aboura, S., Lepinette, E. (2015). New Developments on the Modigliani-Miller Theorem.Browser Download This Pape Cenesizoglu, T., Papageorgiou, N. A., Reeves, J. J., Wu, H. (2016). An Analysis on the Predictability of CAPM Beta for Momentum Returns Vollmer, M. (2014).A Beta-return Efficient Portfolio Optimisation Following the CAPM: An Analysis of International Markets and Sectors. Springer Novak, J. (2015). Systematic risk changes, negative realized excess returns and time-varying CAPM beta.Finance a Uver,65(2), 167 Chen, L. H., Jiang, G. J., Guanzhong, P., Zhu, X. (2016). Biases in CAPM Beta Estimation Annual Report 2016. (2017).www.altium.com. Retrieved 21 January 2017, from https://www.altium.com/resources/investor-announcement/altium_annualreport_2016_web.pdf Altium Ltd. (2017).Yahoo!7 Finance. Retrieved 21 January 2017, from https://au.finance.yahoo.com/q?s=ALU.AX Answer: Concept of Modigliani-Miller Theorem:- The capital structure of Altium Limited is evaluated through the concept Referencess