The finance director of Kingsize plc is currently reviewing the capital structure of the company. She believes that the company is not financing itself in a way that minimises its WACC. The company's financing as at 1 January 20X2 is as follows:
..................................................................................£000
Ordinary shares, £1 each..................................................15,000
Reserves.....................................................................10,000
7% preference shares, £1 each...........................................10,000
10% bonds (redeemable after 7 years) .................................15,000
...............................................................................50,000
Other information (as at 1 January 20X2):
Ordinary share price (ex-div) .............................................£2.65
Preference share price (ex-div) .............................................75p
Bond price for 10% bonds.................................................£102
Last 5 years' dividends (most recent last)..........22p, 23p, 25p, 27p, 29p
The finance director feels that by issuing more debt the company will be able to reduce its cost of capital. She proposes the issue of £15m of 11 per cent bonds. These bonds will be sold at a 5 per cent premium to their nominal value of £100 and will be redeemed after seven years. The cash raised will be used to repurchase ordinary shares which the company will then cancel. She expects the repurchase will cause the company's share price to rise to £2.78 and the future dividend growth rate to rise by 20 per cent (in relative terms). She expects the price of the 10 per cent bonds to be unaffected, but the price of the preference shares to fall to 68p. Corporation tax stands at 30 per cent.
(a) Calculate the current cost of capital (WACC) for Kingsize plc.
(b) Recalculate the company's cost of capital to reflect the proposed changes and comment on the finance director's projections.
(c) Identify and discuss possible inaccuracies that may occur with the finance director's estimates.