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QUESTION B-2 [19 marks] You are investigating the possibility of investing in a local company. This company is a taxation category 2 company and as
QUESTION B-2 [19 marks] You are investigating the possibility of investing in a local company. This company is a taxation category 2 company and as such requires you to calculate the after-tax costs of finance. You have a required rate of return of 5% per annum and, as such, need to identify the rate of return demanded by the investors in this company to compare to your required rate. You have identified the following characteristics for the company. The latest balance sheet shows: Long Term Debt Bonds: Book Value ($) 10,000,000 Issued at par: $1,000 Annual coupon of 4% 6 years to maturity Equity Preference Shares: 1,000,000 1,000,000 shares outstanding Ordinary Shares: 4,000,000 100,000 shares outstanding The company's bank has advised that the interest rate on any new debt finance provided for new projects would be 3.50% per annum. The company's preference shares currently sell for $0.95 each and pay an annual dividend of $0.08 per share. The company's existing ordinary shares currently sell for $47.55 each and pay a dividend per share of $2.50 which has just been paid to shareholders. Dividend growth has been downgraded due to COVID and the company expects that dividend growth will be 1.5% per annum and are expected to continue to do so in the future. The company tax rate is 30%. a) Determine the market value proportions of debt, preference shares and ordinary equity comprising the company's capital structure. (7 marks) b) Calculate the after-tax costs of capital for each source of finance. (4 marks) c) Determine the after-tax weighted average cost of capital for the company. (3 marks) d) Briefly detail why market values should be used to calculate the weighted cost of capital (3 marks) e) Based on your calculations determine whether it is a good idea (or not) to invest in this company. (2 marks)
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