KAFA Company Limited has determined its optimal capital structure. The firm has decided to finance operations by raising 27% of its capital through long-term debt, 25% through preferred stock, and the remaining of the capital through new common stock equity.
SECTION B (50 Marks) ANSWER ALL QUESTIONS FROM THIS SECTION QUESTION 1 (20 marks) KAFA Company Limited has determined its optimal capital structure. The firm has decided to finance operations by raising 27% of its capital through long-term debt, 25% through preferred stock, and the remaining of the capital through new common stock equity. Debt: The firm can sell a 10-vear, e1.000 par value, 8 percent bond for 960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40. Preferred Stock: The firm bas determined it can issue preferred stock at 77 per share par value. The stock will pay a e10 annual dividend. The cost of issuing and selling the stock is $4 per share. New Common Stock: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last four years. Four years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in floatation costs. Additionally, the firm's marginal tax rate is 40 percent. Calculate KAFA Company Limited's weighted average cost of capital to the nearest two decimal places assuming all retained earnings have been exhausted. QUESTION 2 There are two competing proposals for the redevelopment of a piece of vacant land in Accra by KAFA Company Limited mentioned in Question 1. One is to construct an office block ot the site and the other is to construct a casino. You have been asked to give advice on which is the better investment. The two projects generate the following cash flows Year Casino Ofice -300,000 30,000 -300,000 -20,000 400,000 6,000 50,000 120,000 194,000 235,000 (a) What is the Net Present Value of each project? (5 marks) (b) What is the Internal Rate of Return of each project (to the nearest 1%)? (5 marks) (c) Which of the projects will you advice the firm to choose? Why? (4 marks) (d) What are strengths and weaknesses of NPV and the IRR investment decision criteria? (8 marks) (e) What are sunk costs and how are they treated in analyzing cash flows? (4 marks) SECTION B (50 Marks) ANSWER ALL QUESTIONS FROM THIS SECTION QUESTION 1 (20 marks) KAFA Company Limited has determined its optimal capital structure. The firm has decided to finance operations by raising 27% of its capital through long-term debt, 25% through preferred stock, and the remaining of the capital through new common stock equity. Debt: The firm can sell a 10-vear, e1.000 par value, 8 percent bond for 960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40. Preferred Stock: The firm bas determined it can issue preferred stock at 77 per share par value. The stock will pay a e10 annual dividend. The cost of issuing and selling the stock is $4 per share. New Common Stock: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last four years. Four years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in floatation costs. Additionally, the firm's marginal tax rate is 40 percent. Calculate KAFA Company Limited's weighted average cost of capital to the nearest two decimal places assuming all retained earnings have been exhausted. QUESTION 2 There are two competing proposals for the redevelopment of a piece of vacant land in Accra by KAFA Company Limited mentioned in Question 1. One is to construct an office block ot the site and the other is to construct a casino. You have been asked to give advice on which is the better investment. The two projects generate the following cash flows Year Casino Ofice -300,000 30,000 -300,000 -20,000 400,000 6,000 50,000 120,000 194,000 235,000 (a) What is the Net Present Value of each project? (5 marks) (b) What is the Internal Rate of Return of each project (to the nearest 1%)? (5 marks) (c) Which of the projects will you advice the firm to choose? Why? (4 marks) (d) What are strengths and weaknesses of NPV and the IRR investment decision criteria? (8 marks) (e) What are sunk costs and how are they treated in analyzing cash flows? (4 marks)
