The question from textbook: Financial Management Principles and Applications, 6edition

pp. 514.

Clearly information by hand type.

14-21 (Integrated problem) Correlli Ltd, a taxation category 2 company, has done some preliminary evaluation of the following four investment projects, as detailed below.

Investment	Investment Cost	Rate of return (%)
A	$200,000	18
B	$125,000	16
C	$150,000	12
D	$275,000	10

The latest balance sheet for the company shows:

Long-term debt	$
Bonds: Par $100, annual coupon 16.35%, 5 years to maturity	1,500,000
Equity
Preference shares (55,000 shares outstanding, 94 cents dividend)	550,000
Ordinary shares (825,000 shares issued)	1,650,000
Total	$3,700,000

The companys bank has advised that the interest rate on any new debt finance provided for the projects would be 8% p.a.

The companys preference shares currently sell for $9.09, and to induce investors to take up a new offering of preference shares the company would have to set the issue price at a discount of 4% off the present market price.

The companys existing shares sell for $3.03 each and management has disclosed that it expects to pay a dividend of 16 cents at the end of the next year. Historically, dividends have increased at an annual rate of 9% p.a. and are expected to continue to do so in the future. The ordinary equity component to finance new projects will require new shares to be sold at a 10% discount from the current $3.03 price, and the costs for undertaking the new issue are estimated to be 30 cents per share. The company tax rate is 30%.

(a) Determine the market value proportions of debt, preference shares and ordinary equity comprising the companys capital structure.

(b) Calculate the after-tax costs of finance for each source of finance.

(c) Determine the after-tax weighted average cost of finance for the company.

(d) Determine which investments should be made.