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11 Dec 2019

The preference shares of Ronaldo Co. pays a $2.75 dividend per share. What is the value of the preference shares if your required return is 8%?

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Beverley Smith
Beverley SmithLv2
13 Dec 2019
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Ronaldo Fiber Industries, a fiber optic company is considering to optimize its capital structure. Its targeted capital structure consists of 20% debt, 30% preferred stocks and 50% common stocks. Ronaldo Fiber Industries has been paying dividend 30% of its net income regularly. The current stock price is Rs. 54, and a constant growth rate is 9%. Metal fiber Industries expecting next year's earning to be Rs. 44,000,000. Last year dividend paid Rs. 3.60 by the company. The corporate tax rate is 40%. Metal Fiber Industries issued bonds of 12 years with a coupon rate of 10% and currently trading at a price of 945. They are also considering issuing new preferred stock at 11%.

Required:
 What is the cost of each of the capital components of Ronaldo Fiber Industries?
 What is Ronaldo Fiber Industries’ WACC?

Quest Exploration Ltd is trying to take advantage of the commodity boom by increasing its exploration activities. However, as a junior mining company it will need to raise additional capital over the coming year. The tax rate of the company is 30%. As financial manager, you have prepared the following information and financial data.

Debt: Quest Exploration can raise an unlimited amount of debt by selling $1,000 par (face) value, 6.5% coupon interest 10-year bonds. In order to sell the issue, an average discount of $20 per bond needs to be given. Additionally, floatation costs of 2% of par value will be incurred.

Preference shares: An unlimited number of preference shares can be sold under the following terms: the shares have a face value of $100 per share, the annual dividend rate is 6% of the face value and the floatation cost is expected to be $4 per share. The preference shares are expected to sell for $102 before cost considerations.

Ordinary shares: The current price of Quest Exploration’s ordinary shares is $35 per share. A cash dividend of $3.00 per share was recently paid. The firm’s dividends have grown at an annual rate of 5% and are expected to grow at this rate in the foreseeable future. The floatation cost is expected to be approximately $2 per share.

Retained earnings: Quest Exploration expects to generate $100,000 of retained earnings in the coming year.

Required:

Calculate the specific cost of each source of financing. (Round your answer to the nearest 0.01%).

In a "perfect world" capital market, how important is a firm’s decision to pay dividends versus repurchase shares? Under what conditions would you have a tax preference for share repurchase rather than dividends? Would managers acting in the interests of long-term shareholders be more likely to repurchase shares if they believed the stock to be either undervalued or overvalued? Lastly, explain how you would respond to firm’s decision to cut its dividend

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