Question: 1

Emmar construction is a Muscat based construction company planning to raise funds for an expansion of existing business activities in other regions of middle east and in preparation for this the company has decided to calculate its weighted average cost of capital (WACC). Emmar company has the following capital structure:

RO. Million

Equity

Ordinary shares

200

Reserves

650

850

Non-current liabilities Loan notes

200

1,050

The ordinary shares of Emmar company have a nominal value of 500 cents per share and are currently trading on the stock market on an ex dividend basis at RO. 5.85 per share. Emmar company has an equity beta of 1.15.

The loan notes have a nominal value of RO. 100 and are currently trading on the stock market on an ex interest basis at RO. 103.50 per loan note. The interest on the loan notes is 6% per year before tax and they will be redeemed in six years' time at a 6% premium to their nominal value.

The risk-free rate of return is 4% per year and the equity risk premium is 6% per year. Emmar company pays corporation tax at an annual rate of 25% per year. Required:

a) Imagine Emmar company's finance director has proposed in their recent board meeting to raise RO. 700 million by issuing loan notes. You are required to discuss about Emmar company's current capital structure, also how it will change and affect the company capital structure and risk profile, if the Board accepted the Finance director's proposal.

b) You are required to Calculate the market value weighted average cost of capital and the book value weighted average cost of capital of Emmar company, and comment briefly on any difference between the two values.

(6 Marks)

c) You are required to discuss the factors to be considered by Emmar company if they choose to raise RO. 700 million through a rights issue.