COST OF CAPITAL Shoreline Ltd.’s, total capital expenditures for the financial y
ID: 2731130 • Letter: C
Question
COST OF CAPITAL
Shoreline Ltd.’s, total capital expenditures for the financial year ending 30 September 2013 are yet to be determined. The Financial Manager has set a policy to maintain the current capital structure proportions of 30 per cent interest-bearing debt, 20 per cent preference share capital and 50 per cent ordinary share capital for at least the next three years. The tax rate is 30%.
FINANCING COST DATA
Interest-bearing debt
The firm can raise additional debt by selling ten-year, $1000, 8 per cent annual interest rate bonds to net $870 after flotation costs.
Preference shares
regardless of the amount sold, can be issued for $50 with a 15 per cent annual dividend rate, and will net $45 per share after flotation costs.
Ordinary Shares
The current year ordinary dividend per share is $1.75. The firm expects its dividends and earnings to continue to grow at a constant rate of 12 per cent per year. The firm can sell new ordinary shares, regardless of the amount sold, at $15 per share after flotation costs.
(a) Calculate the after-tax cost of each of the following sources of Shoreline Ltd’s current financing:
(i) Cost of debt
(ii) Cost of preference shares
(iii) Cost of ordinary share equity (using the Gordon’s constant growth model)
(b) Calculate the Weighted Average Cost of Capital (WACC) of Shoreline Ltd’s financing.
Explanation / Answer
Answer:(a)
(i) Cost of Debt:
870=80*PVIFA(8%,10)+$1000*PVIF(8%,10)
R=10.13%
Cost of Debt after tax=10.13%(1-0.30)
=7.091%
Answer:(ii) Cost of Preference shares=(50*15%)/$45
=7.5/45=16.67%
Answer:(iii) Cost of Equity=
[$1.75/$15]+12%
=23.67%
Answer:(b)
Capital structure Weight Cost of capital WACC Debt 30% 7.09% 2.13% Preference shares 20% 16.67% 3.33% Equity share 50% 23.67% 11.84% Total 17.30%Related Questions
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