Syndicate Ltd. is re-evaluating the rate of return demanded by its investors for new projects with the following projects being reviewed by the board for possible investment:
Investment
|
Investment Cost ($)
|
Rate of Return (%)
|
A
|
1,500,000
|
15
|
B
|
2,000,000
|
12
|
C
|
5,000,000
|
9
|
D
|
750,000
|
6
|
The latest balance sheet for Syndicate Ltd shows:
Long Term Debt Book Value ($)
Bonds:
Issued at par: $100 5,000,000
Annual coupon of 6%
4 years to maturity
Equity
Preference Shares: 1,000,000
100,000 shares issued
Ordinary Shares: 4,000,000
1,000,000 shares issued
The company’s bank has advised that the interest rate on any new debt finance provided for new projects would be 8% p.a.
The company’s preference shares currently sell for $9.35 each, and pay a dividend of $1.10 per share.
The company’s existing ordinary shares sell for $4.15 each and pay a dividend per share of $0.55 , which has just been paid to shareholders. Historically, dividends have increased at an annual rate of 2% p.a. and are expected to continue to do so in the future.
Syndicate’s company tax rate is 30%.
- Determine the market value proportions of debt, preference shares and ordinary equity comprising the company’s capital structure.
Briefly
detail why market values should be used to calculate the weighted cost of capital
- Calculate the after-tax costs of capital for each source of finance.
Determine the after-tax weighted average cost of capital for the company.