QUESTION 1

Delima Berhad is planning to invest in a new project in West Borneo. The project would have essentially similar risk as its existing projects. The company needs to determine the appropriate discount rate for evaluation purposes. Currently, it has 1 million common shares outstanding, which is selling at RM11.25 per share. Next year, the dividend is expected to be RM1 per share and estimated to grow at 5% annually. Floatation costs for new common shares would be RM0.10 per share. Nevertheless, the company has decided not to issue any new common shares as it has sufficient cash in hand for the equity financing.

In addition, the company has 150,000 preferred shares outstanding at a market price of RM9.50 per share. It pays fixed dividend of RM0.95 per share. Should the company intend to issue new preferred shares, they must be sold at 5% less than the current market price and involve direct floatation costs of RM0.25 per share. Besides the shares, the company has a total par value of RM10 million in debts outstanding. The debt is in the form of bonds with 10 years remaining to maturity with the coupon rate of 11.3%. Each bond is selling at 6% premium above its par value. Floatation costs for new bonds would equal to 6% of the par value. The company's tax rate is 40%.

Required:

i. Calculate the cost of equity. (2 marks)

ii. Determine the cost of preferred shares and after-tax cost of debt. (6 marks)

iii. Calculate the WACC for the new project. Comment on the results. (4 marks)