Question
The following is an extract of the statement of financial position of Highland Ltd $'m Ordinary shares ($1 per value) 25 Retained earnings 15 Total
The following is an extract of the statement of financial position of Highland Ltd
$'m | |
Ordinary shares ($1 per value) | 25 |
Retained earnings | 15 |
Total shareholders' equity | 40 |
7% convertible bonds ($100 par value) | 20 |
5% preference shares ($1 par value) | 10 |
Total non-current liabilities | 30 |
Trade payables | 25 |
Total current liabilities | 25 |
The ordinary shares of the company have a beta of 1.2 and the current stock price is $5.00 per share. The CFO has determined that the current risk-free rate of return is 4% and the stock market has in the past earned excess return of 5% over this risk free rate.
The current market value of each preference share is $0.625.
The convertible bonds have a market value of $21 million. They mature in 5 years and, at that time, the bonds can be converted into 18 ordinary shares of the company per $100 par value of bond. The CFO expects the stock price to appreciate by 5% per year.
Required
(a) Calculate the cost of ordinary equity
(b) Calculate the cost of preferred equity
(c) Calculate the cost of debt, assuming that the CFO's expectation of stock price appreciation is valid.
(d) Calculate the WACC.
(e) If the company does not have to pay any corporate tax, discuss whether the valuation of the company will be enhanced if it uses more debt as opposed to equity financing
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