Question 2

Robert Bernard is an investment analyst employed to JMMB. He was requested to assess the capital structure of Worthy Park Estate Rums and has provided the following information:

Preferred Stock:

13 000 shares of 8 percent preferred stock issued at $100.00 per share. Current market price is

$80 per share.

Common Stock:

60 000 shares outstanding, selling for $105 per share. The current Treasury bill rate is 12% and

the stocks beta is 1.50. The expected rate of return on the average stock in the market is 16%.

Debt

The firm can borrow funds at 23% interest per year. Assume that the tax rate is 30%.

a. Using the information above to calculate the firms WACC if the target capital structure comprises 40% debt, 20% preferred stock and 40% common stock. (13 marks)

b. If the beta of the stock was two (2) and the firms capital structure was modified to 40% debt, 10% preferred stock, and 50% common, what is the firms WACC? (6 marks)

c. The firm is expected to pay a year end dividend of $10.00 per share at year end and its flotation cost if 10%. Investors have projected an expected growth rate of 8% per annum.

i. What is the cost of retained earnings using the discounted cash flow approach?

(3 marks)

ii. Calculate the cost of issuing new common stock. (3 marks)

(Total 25 marks