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Prince Publications Ltd (PPL) wishes to estimate its weighted average cost of capital. It has two sources of capital: ordinary shares and 5-year bonds. Currently, the market value of the shares is $18.45 per share and the market value of the bonds is $115.080 per $100 par value. The shares have recently paid an annual dividend of $2.52 per share and the bonds have recently paid an annual coupon interest of $12.80 per $100 par value. The face value of the bonds on issue is $115 million. There are 13,500,000 ordinary shares on issue. The expected growth rate of dividends per share is 2.3% p.a.. Ignore taxes. PPL’s weighted average cost of capital is closest to: a) 13.52% p.a. b) 13.73% p.a. c) 13.95% p.a. d) 15.07% p.a.

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Tod Thiel
Tod ThielLv2
28 Sep 2019

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QUESTION 4 [Total 15 marks]

Chico Scroll Limited is a medium sized Australian manufacturing company whose shareholders cannot benefit from imputation credits. Its current capital structure comprises 100 million shares currently trading at $3.80 each, and $100 million face value (there are 1 million bonds on issue, each with a face value of $100) of 5 year bonds with yearly coupons payable at an interest rate of 10% p.a. The bonds are currently trading at a yield of 7.17% p.a. As the finance manager for the Chico Scroll Company you have to approve all new projects.

Recently the marketing department presented a proposal for a major new advertising campaign. It believes that a promotional campaign comprising print and TV advertising in the 2 weeks before Christmas 2004 costing $5m will yield increased sales over the next three years, translating into after-tax cash inflows of:

Year 1 $3,600,000

Year 2 $2,200,000

Year 3 $1,400,000

The finance manager has gathered the following financial information:

 The current yield on 5 year government bonds is 5% p.a.

 The historical return on the ASX sharemarket index has been 15% p.a.

 Shares in Chico Scroll Limited have a beta of 1.4

 The company pays tax at the rate of 30%

 The company is able to raise funds through the placement of shares and bonds at current market values.

(a) Calculate the weighted average cost of capital (WACC) for the project and then calculate the net present value (NPV) to determine whether the company should accept or reject this project. (12 marks)

(b) How confident are you that your decision about the project is correct? Briefly detail which components of your evaluation you think may warrant further investigation and why.

(3 marks)

Andy has 68,000 shares of common stock outstanding at a market price of $46 a share. The common stock just paid a $2.62 annual dividend and has a dividend growth rate of 5.5 percent. There are 22,000 shares of 5.5 percent preferred stock outstanding at a market price of $62 a share. The preferred stock has a par value of $100. The outstanding bonds mature in 11 years, have a total face value of $850,000, a face value per bond of $1,000, and a market price of $970 each. The bonds pay 7.5 percent interest, semiannually. The tax rate is 34 percent. What is the firm's weighted average cost of capital?

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%).

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