Question 2 (20 marks) Rick Limited is trying to calculate its cost of capital for sin capital budgeting decision. The CFO has given you the following information and has asked you to compute the weighted average cost of capital (WACC). Delts (Boods only) The company currently has outstanding a bond ("Bond A") with a 12.2%.coupon rate and another bond("Bond B") with a 9.5% coupon rate. The company has been informed by its investment banker that bank of equal risk and credit rating we now selling to yield 13,6%. The total book value of Bond A and B is $200,000,000, and the total market value is $170,000,000 Common stock The company has 8,200,000 common stock outstanding, and each has a par value of $15 The current market value of the common stock is $58 per share and it has just paid dividend of $4.8 per share. The firm's historical growth rate of earnings and dividende per share has been 9.5%, but security analysts on Wall Street expect this growth to show 10 7% in coming year and the future years. Preferred stock The company has 630,000 preferred stock outstanding, and each has a par value of $50 with 13.5% dividend rate on par value. The preferred stock is currently trading at 554 per share on stock exchange. Additional information 1. The company is subject to 25% corporate tax rate, 2. The company will maintain the current optimal capital structure, based on the respective source of capital's current market value Required: 1. Calculate the cost of debt, cost of common stock and cost of preferred stock. (10 marks) 2. Calculate the respective percentage of debt, common stock and preferred stock 10 Rick Limited's current optimal capital structure. (8 marks 3. Calculate Rick Limited's WACC. (4 marks) 4 Comment if you agree or disagree to the following statements: (8 marks) Statement : A firm that does not earn the cost of capital in the short run will probably be in honkruptcy ." Statement 2: "The cost of capital, or WACC Es not the correct duscount rate to use for all projects undertaken by a company Statement 3 "Firms in stable Industries are advised to keep debt levels very low so that shareholders, rather than creditors, recene the benefits of ready cash flows Question 2 (20 marks) Rick Limited is trying to calculate its cost of capital for sin capital budgeting decision. The CFO has given you the following information and has asked you to compute the weighted average cost of capital (WACC). Delts (Boods only) The company currently has outstanding a bond ("Bond A") with a 12.2%.coupon rate and another bond("Bond B") with a 9.5% coupon rate. The company has been informed by its investment banker that bank of equal risk and credit rating we now selling to yield 13,6%. The total book value of Bond A and B is $200,000,000, and the total market value is $170,000,000 Common stock The company has 8,200,000 common stock outstanding, and each has a par value of $15 The current market value of the common stock is $58 per share and it has just paid dividend of $4.8 per share. The firm's historical growth rate of earnings and dividende per share has been 9.5%, but security analysts on Wall Street expect this growth to show 10 7% in coming year and the future years. Preferred stock The company has 630,000 preferred stock outstanding, and each has a par value of $50 with 13.5% dividend rate on par value. The preferred stock is currently trading at 554 per share on stock exchange. Additional information 1. The company is subject to 25% corporate tax rate, 2. The company will maintain the current optimal capital structure, based on the respective source of capital's current market value Required: 1. Calculate the cost of debt, cost of common stock and cost of preferred stock. (10 marks) 2. Calculate the respective percentage of debt, common stock and preferred stock 10 Rick Limited's current optimal capital structure. (8 marks 3. Calculate Rick Limited's WACC. (4 marks) 4 Comment if you agree or disagree to the following statements: (8 marks) Statement : A firm that does not earn the cost of capital in the short run will probably be in honkruptcy ." Statement 2: "The cost of capital, or WACC Es not the correct duscount rate to use for all projects undertaken by a company Statement 3 "Firms in stable Industries are advised to keep debt levels very low so that shareholders, rather than creditors, recene the benefits of ready cash flows
