The capital structure for Nealon Ltd. (a taxation category1 company) is provided

Question

The capital structure for Nealon Ltd. (a taxation category1 company) is provided below. Issue costs would be (a) 15% of market value for a new bond issue, (b) 12 cents per share for ordinary shares, and (c) 20 cents per share for preference shares. The fully franked ordinary share dividends for next year will be 16.75 cents and are projected to have an annual growth rate of 6%. What is the weighted cost of capital if the firm finances in the proportions shown below? Market prices are $103.50 for bonds, $1.90 for preference shares and $3.50 for ordinary shares. There will be $500,000 of retained profits available.The company tax rate is 30%.

Nealson Ltd. of balance sheet:

Type of Financing Percentage of
Future Financing
Bonds (8%, $100 par, 16 year maturity) 38
Preference shares (5,000 shares outstanding, 15
15 cents franked dividend)
Ordinary equity 47
Total 100

Explanation / Answer

Weighted avg Cost of capital : = wE*rE + wP*rP+wD*rD*(1-Tc) WEights are wD =0.38 wP= 0.15 wE= 0.47 rE= [D1/ P0(1-F) ] + g = [0.1675 cents /3.50(1-0.0343)]+0.06 =10.95% rP= 0.15Cents / $1.90(1-F) =0.15/$1.90(1-0.105) = 0.0882percent =8.82% rD= 8%*(1-0.3) =5.6% Substitiute these vlaues into above fromula .. = 0.47*(0.1095)+.15*(0.0882)+0.38*(0.056) =8.597% =8.6% Note : Here the bonds market price is given ,but we dont need to caliculate yield on bonds to caliculate the WAcc.

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