QUESTION (20 MARKS)

On 31 December 2017, the total assets of Stream Berhad were RM10 million. The firm plans to invest in new projects costing RM5 million. Currently, the capital structure of the company, which is considered optimal is as follows:

Debt RM3,500,000

Common stock RM6,500,000

Total RM10,000,00

To finance the projects, the company plans to issue 9% Irredeemable Bonds at RM970 with a flotation cost of RM20 per bond. Common stock can be issued at its current market price of RM5 per share. Flotation cost of 5% on market price will be incurred. The stockholders required return is estimated to be 10% consisting of a divinded yield of 4% and an expected growth rate of 6%. Next years expected divinded is 30 sen per share.

The company earned net profit after tax of RM3 million. However, dividends of RM0.28 per share will be paid on 1 million shares outstanding immediately. Only earnings after dividend would be available for investment purposes. The corporate tax rate is 28%.

1. Determine the after-tax cost of:

1. New debt
2. Retained earnings
3. New common stock

b. What would be the maximum size of the capital budget (in RM), if the company plans to use only retained earnings for the equity portion?

c. Calculate the firms weighted average cost of capital if the above investments are undertaken.

d. Calculate the number of ordinary shares to be issued by Stream Berhad if the project is undertaken, assuming that the equity portion comes from a new issue of shares.