Question
Your client has also provided the below information for you to evaluate the possibility of the investment into this company. The company is located in
Your client has also provided the below information for you to evaluate the possibility of the investment into this company. The company is located in Australia, as is your client, which requires you to calculate the after-tax costs of finance. Your client has a required rate of return of 5% per annum and, as such, requires you to identify the rate of return demanded by the investors in this company to compare to your clients required rate. You have identified the following characteristics for the company.
The latest balance sheet shows:
Long term Debt | Book Value ($) |
Bonds: Issued Par: $100 Annual Coupon of 6% 8 years to maturity Equity | 70,000,000 |
Preference Shares: 500,000 shares outstanding | 10,000,000 |
Ordinary Shares: 5,000,000 shares outstanding | 20,000,000 |
The companys bank has advised that the interest rate on any new debt finance provided for new projects would be 5% per annum. The companys preference shares currently sell for $26.34 each and pay an annual dividend of $1.50 per share.
The companys existing ordinary shares currently sell for $4.21 each and pay a dividend per share of $0.25 which has just been paid to shareholders. Dividend growth has been downgraded due to COVID and the company expects that dividend growth will be 3% per annum and are expected to continue to do so in the future.
The company tax rate is 30%.
Questions
1. Determine the after-tax weighted average cost of capital for the company. Provide all working and steps for the calculation of the after-tax weighted average cost of capital.
2. Based on your calculations determine whether it is a good idea (or not) to invest in this company. Provide a rationale for this decision.
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