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Natural Food Limited is considering setting up a new farm. It is expected that the farm will generate annual after-tax net cash flows of $8,400,000 in perpetuity, with an initial outlay of $30,000,000. Currently, the corporate tax rate is 16% and Natural Food Limited is financed as follows:

– Retained earnings of $15,000,000

– 1,000,000 ordinary shares with a par value of $1, currently trading at $15 each. The dividend for the last year was $0.8, with an annual dividend growth rate of 2%.

– 50,000 shares of 6% preferred stock (with a $100 par value), now selling for $250 per share

– 40,000 8.5% 10-year coupon bonds with a par value of $2,000 and currently trading at 102% of par. Coupons are payable semi-annually.

– A long-term bank loan of $45,000,000 at 4%.

a When the weighted average cost of capital (WACC) is used by financial managers to evaluate investment decisions, the assumptions underlying the WACC should be taken into consideration. Please discuss these assumptions. (15 marks)

b Determine the weighted average cost of capital for Natural Food Limited. (35 marks)

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Casey Durgan
Casey DurganLv2
10 Jan 2018

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20. You are given the following information for United Aircraft. Assume the company’s tax rate is 30%.

Preferred Stock: 26,000 shares of preferred stock outstanding, with a dividend of $6.00. The preferred stock currently sells for $105 per share

Common Stock: 500,000 shares outstanding, selling at $75 per share. The current dividend is $3.00 per share, and the dividend is expected to grow at 4%

Debt: 8,000 bonds outstanding. They have a 4.8% coupon, $1,000 par value, 15 years to maturity, selling for 93% of par; coupons are paid semi-annually

A. What are the required returns for Common Stock, Preferred Stock and Debt?

B. What is the WACC for United Aircraft?

Suppose you are given the following information for the Catch-them-all Inc.

Debt: 23,000 bonds outstanding, with a face value of $2,000. The bonds currently trade at 81.125% of par value, and have 30 years to maturity. The coupon rate equals 3%, and the bonds make semi-annual coupon payments.

Common stock: 825,000 shares of common stock outstanding; currently trading for $62.55 per share. The firm just paid a dividend of $3.94 per share, and dividends are expected to grow at 2% per year, forever.

Preferred stock: 150,000 shares of preferred stock outstanding; currently trading for $107.5 per share; pays a $4.82 dividend every year.

Tax rate: 35%

Calculate the before tax cost of debt (Rd), cost of equity capital, capital structure weight of debt, and weighted average cost of capital. (Enter percentages as decimals and round to 4 decimal places)

9. Reference is made to the 2015 Balance Sheet of Southwest limited.

Southwest Limited Balance Sheet 2015

Cash 1,000,000.00 Accounts Payable 8,000,000.00

Acc. Receivable 12,000,000.00 Notes Payable 8,500,000.00

Marketable securities 3,000,000.00 Long-term Debt 20,000,000.00

Inventories 7,500,000.00 Common stock 7,500,000.00

Fixed Assets 26,500,000.00 Preferred Stock 6,000,000.00

Total Assets 50,000,000.00 Total Liabilities and Equity 50,000,000.00

Additional Information:

i. The Long-Term debt consists of 8% annual coupon bonds, with 15 years to
maturity and are currently selling for 95% of par.
ii. The company’s common shares which have a book value of $20 per share are
currently selling at $25 per share.
iii. Preferred shares have a book value of $100 per share. These shares are currently
selling at $120 per share and pays dividends of 6% per annum.
iv. The dividend growth rate is expected to be 3%, and dividend for 2016 is projected
to be $5.00 per share.
v. The Company’s Tax rate is 30%.

Required:

Determine the following for Southwest Limited:

(a) Total Market value of the firm’s capital structure
(b) After-tax Cost of Debt
(c) Cost of Common Stock
(d) Cost of Preferred Stock
(e) WACC

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