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 Explorationâs ordinary shares is $35 per share. A cash dividend of $3.00 per share was recently paid. The firmâs 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%).
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 Explorationâs ordinary shares is $35 per share. A cash dividend of $3.00 per share was recently paid. The firmâs 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%).
Related questions
Erwin Enterprises is a large publicly listed company and is the market leader in vacuum cleaner manufacturing. The company is looking to set up a manufacturing plant overseas to produce a new line of commercial vacuum cleaners. This will be a six-year project. The company bought a piece of land four years ago for $ 8 million in anticipation of using it for its proposed manufacturing plant. If the company sold the land today, it would receive $ 9.75 million after taxes. In six years the land can be sold for $7 million after taxes and reclamation costs. Erwin Enterprises wants to build a new manufacturing plant on this land. The plant will cost $320 million to build. The following market data on Erwinâs securities are current:
| Debt | $120,000,000,7.25% coupon bonds outstanding with 20 years to maturity redeemable at par, selling for 95 percent of par; the bonds have a $1000 par value each and make semi-annual coupon payments. |
| Equity | 15,000,000ordinary shares, selling for $55 per share |
| Non-redeemable Preference shares | 12,000,000 shares (par value $ 10 per share) with 6.5% dividends (after taxes), selling for $32 per share |
The following information is relevant:
Erwin Enterprisesâ tax rate is 28%
The company had been paying dividends on its ordinary shares consistently. Dividends paid during the past five years is as follows
| Year (-4) ($) | Year (-3) ($) | Year (-2) ($) | Year (-1) ($) | Year (0) ($) |
| 4.6 | 4.8 | 5.2 | 5.5 | 6.1 |
The project requires $ 8.25 million in initial net working capital investment in year 0 to become operational.
Work all solutions to the nearest two decimals.
Required:
Calculate the projectâs initial, (time 0) cash flows, taking into account all side effects.
(2 marks)
Compute the weighted average cost of capital (WACC) of Erwin Enterprises. Show all workings and state clearly the assumptions underlying your computations.
(10 marks)
Using the WACC computed in part (2) above and assuming the following, compute the projectâs Net Present Value (NPV), Internal Rate of Return (IRR) and the Profitability Index (PI)
The manufacturing plant has a ten-year tax life, and Erwin Enterprises uses Diminishing value method depreciation for the plant at 25% per annum. At the end of the project, (i.e. at the end of year 6), the plant can be scrapped for $ 42 million.
The project will incur $220 million per annum in fixed costs
Erwin Enterprises will manufacture 280,000 commercial vacuum cleaners per year in each of the years and sell them at $ 2,200 per vacuum cleaner.
The variable production costs are $ 800 per vacuum cleaner.
At the end of year 6, the company will sell the land.
(7 marks)
2.2. What are the pros and cons of using risk-adjusted costs of capital for individual investments?
(5 marks
