3. Compute the weighted average cost of capital for RIC Inc. using the following

Question

3. Compute the weighted average cost of capital for RIC Inc. using the following information RIC Inc. has decided to finance this product line expansion by raising new capital. The company's optimal capital structure calls for 35% debt, 40% equity, and 25% preferred stock. RIC Inc. can issue a series of8% coupon bonds with a $1000 par value. The onds will mature in 10 years and will sell for $946 minus an issuance cost of $5. RIC Inc.'s marginal tax rate is 35%. RIC Inc.'s common stock is currently selling for $22 per share. Its present dividend is $1.96 a share and the expected long-term dividend growth rate is 8.5%, what is the cost of external equity for RIC Inc. assuming an issuance cost of $2.00 per share? RIC Inc. has just issued shares of preferred stock that pay an annual dividend of $2.15. The preferred stock was sold to the public at a price of $52.00 per share with issuance cost of $2.00 per share. What is the marginal cost of preferred stock for RIC Inc.? a) Using the WACC, recalculate the NPV. Should RIC Inc. undertake the investment? When should a company undertake an investment using the NPV? b) c) Compare the IRR computed (2c) with the WACC. Should RIC Inc. go ahead with the project? (A simple "Yes" or "No" will not do.) d) When should a company undertake an investment using the IRR?

Explanation / Answer

For Calculation of NPV and IRR for decision making the necessary information is not provided

Cost of Preference Shares Market Value 52 Preference Dividend 2.15 Issuance Cost 2 Net Proceeds 52-2 50 Assuming the period of redemption is 10 years Redemption Value [PD+(RV-NP)/N]/[RV+NP)/2] 2.15 (RV-NP)/10 0 (RV+NP)/2 50 Kp 4.3 4.30% Cost of Equity Shares Ke [Dividend per share(D1)/Market Price per share(P0)]+growth rate(g) D1 D0*(1+g) 1.96*(1+0.085) 2.1266 Net Proceeds 20 Ke D1/P0 0.10633 Ke=D1/P0+g 19.133% Cost of Debt Coupon rate 8% Issued Value 1000 Period 10 years Rededmption value 946 Floatation cost 5 Marginal tax rate 35% Net Proceeds Par value of shares-Floatation costs 1000-5 995 After tax debt 80 52 Kd {[After tax Interest Payment+(Redemption value-Net Proceeds)/2]}/{[redemption value+Net proceeds]/2} [52+(946-995)/10] [(946+995)/2] -4.9 52 47.1 970.5 4.853168 4.8532 Weighted Average Cost of Capital Particulars Cost of funds Proportion WACC Equity 19.13% 40% 8% Preference Stock 4.30% 25% 1% Debt 4.85% 35% 2% 10%

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