You are working in the Finance Department of Raceme Manufacturing and your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the firm's present capital structure reflects the appropriate mix of capital sources for the firm, you have determined the market value of the firm's capital structure as follows:

Source of Capital

Market Values

Bonds

$3,500,000

Preference Shares

$2,500,000

Ordinary Shares

$5,000,000

To finance the purchase, Raceme Manufacturing will sell 10 year bonds paying interest at a rate of 7 percent per year (with interest paid semiannually) at the market price of $1,050. Preferred stock paying a $2 dividend can be sold for $25. Common stock for Raceme Manufacturing is currently selling for $55 per share, and the firm paid a $3 dividend last year. Dividends are expected to continue growing at a rate of 5 percent per year for the indefinite future. If the firm's tax rate is 30 percent, what discount rate should you use to evaluate the equipment purchase?

Use the formula sheet at the end of the question paper to answer the below questions.

Required:

(a)What is cost of Raceme Manufacturing's Bonds? (5 marks)

[Answer and show workings here]

(b)What is Raceme Manufacturing's cost of preference shares? (5 marks)

[Answer and show workings here]

(c)What is the cost of Raceme Manufacturing's ordinary shares? (5 marks)

[Answer and show workings here]

(d)What is Raceme Manufacturing's WACC? (5 marks)

[Answer and show workings here]

Formulas required:

1.R* = P₁ x R₁ + P₂ x R₂ + P₃ x R₃ ... + P_n x R_n

2.Valuation of Bonds

V_b = $ I (PVIFA_i,n) + $ M (PVIF_i,n)

3.Valuation of preference share

V_p = Annual dividend (D) / Required rate of return (R_p)

4.Valuation of ordinary shares

V_E = D₁ / (1 + R_E ) + P₁ / (1 + R_E )

5.Cost of Bond

P₀ = $ I (PVIFA_i,n) + $ M (PVIF_i,n)

6.Cost of Preference Share

7.Cost of Ordinary equity

8.CAPM approach: Cost of Capital provided by retained earnings

9.Cost of Debt

K_d = K_{d, BT*} (1 - T)

10.Weighted Average Cost of Capital: Total cost of equity * Total Weight of equity

Time Value of Money - Tables

Present Value of $1

N

2%

3%

4%

5%

6%

7%

8%

9%

10%

1

0.980

0.971

0.962

0.952

0.943

0.935

0.926

0.917

0.909

2

0.961

0.943

0.925

0.907

0.890

0.873

0.857

0.842

0.826

3

0.942

0.915

0.889

0.864

0.840

0.816

0.794

0.772

0.751

4

0.924

0.888

0.855

0.823

0.792

0.763

0.735

0.708

0.683

5

0.906

0.863

0.822

0.784

0.747

0.713

0.681

0.650

0.621

6

0.888

0.837

0.790

0.746

0.705

0.666

0.630

0.596

0.564

7

0.871

0.813

0.760

0.711

0.665

0.623

0.583

0.547

0.513

8

0.853

0.789

0.731

0.677

0.627

0.582

0.540

0.502

0.467

9

0.837

0.766

0.703

0.645

0.592

0.544

0.500

0.460

0.424

10

0.820

0.744

0.676

0.614

0.558

0.508

0.463

0.422

0.386

11

0.804

0.722

0.650

0.585

0.527

0.475

0.429

0.388

0.350

12

0.789

0.701

0.625

0.557

0.497

0.444

0.397

0.356

0.319

13

0.773

0.681

0.601

0.530

0.469

0.415

0.368

0.326

0.290

14

0.758

0.661

0.577

0.505

0.442

0.388

0.340

0.299

0.263

15

0.743

0.642

0.555

0.481

0.417

0.362

0.315

0.275

0.239

16

0.728

0.623

0.534

0.458

0.394

0.339

0.292

0.252

0.218

Time Value of Money - Tables

Present Value of an Annuity of $1 for n periods

N

2%

3%

4%

5%

6%

7%

8%

9%

10%

1

0.980

0.971

0.962

0.952

0.943

0.935

0.926

0.917

0.909

2

1.942

1.913

1.886

1.859

1.833

1.808

1.783

1.759

1.736

3

2.884

2.829

2.775

2.723

2.673

2.624

2.577

2.531

2.487

4

3.808

3.717

3.630

3.546

3.465

3.387

3.312

3.240

3.170

5

4.713

4.580

4.452

4.329

4.212

4.100

3.993

3.890

3.791

6

5.601

5.417

5.242

5.076

4.917

4.767

4.623

4.486

4.355

7

6.472

6.230

6.002

5.786

5.582

5.389

5.206

5.033

4.868

8

7.326

7.020

6.733

6.463

6.210

5.971

5.747

5.535

5.335

9

8.162

7.786

7.435

7.108

6.802

6.515

6.247

5.995

5.759

10

8.983

8.530

8.111

7.722

7.360

7.024

6.710

6.418

6.145

11

9.787

9.253

8.760

8.306

7.887

7.499

7.139

6.805

6.495

12

10.575

9.954

9.385

8.863

8.384

7.943

7.536

7.161

6.814

13

11.348

10.635

9.986

9.394

8.853

8.358

7.904

7.487

7.103

14

12.106

11.296

10.563

9.899

9.295

8.746

8.244

7.786

7.367

15

12.849

11.938

11.118

10.380

9.712

9.108

8.560

8.061

7.606

16

13.578

12.561

11.652

10.838

10.106

9.447

8.851

8.313

7.824