Question

Part B

Bruhaha Ltd (BL) is an Australian publicly listed firm on the ASX. The company has a long-term target capital structure of 50% ordinary equity, 10% preference shares, and 40% debt. All shareholders of BL are Australian residents for tax purposes.

To fund a major expansion BL Ltd needs to raise a $200 million in capital from debt and equity markets.

BL’s broker advises that they can sell new 10 year corporate bonds to investors for $105 with an annual coupon of 6% and a face value of $100. Issue costs on this new debt are expected to be 1% of face value.

The firm can also issue new $100 preference shares which will pay a dividend of $7.50 and have issue costs of 2%.

The company also plans to issue new ordinary shares at an issue cost of 2.5%. The ordinary shares of BL are currently trading at $4.50 per share and will pay a dividend of $0.15 this year. Ordinary dividends in BL are predicted to grow at a constant rate of 7% pa.

1. Calculate the total value and the quantity of debt BL will need to issue to maintain their target capital structure.
2. What will be the appropriate cost of debt for BL?   
3. Calculate the total value and quantity of preference shares BL will need to issue to maintain their target capital structure.
4. What will be the appropriate cost of preference shares for BL?   
5. Calculate the total value and quantity of ordinary shares BL will need to issue to maintain their target capital structure.   
6. What will be the appropriate cost of ordinary equity shares for BL?   
7. Calculate the Weighted Average Cost of Capital (WACC) for BL Ltd following the new capital raising.   
8. BL Ltd has a current EBIT of $1.3 million per annum. The CFO approaches the Board and advises them that they have devised a strategy which will lower the company’s cost of capital by 0.5%. How will this change the value of the company? Support your answer using theory and calculations.   

I have tried to calculated all workings with "After Tax methods", but not sure whether I have to answer Question A-G with “after tax”, or “before tax”… Can you please clarify?? Any please explain why....

Please answer above question, not Question A-G

Answer 1

As the question is about company listed in Australian Stock Exchange and all the shareholders are Autralian resident for tax purposes, we can asssume the prevailing corporate tax rate in Australia for calculation of cost of capital.

But it is not essential to have calculation with tax rate as the question does not mention about tax rate.

It is at the discretion of the person who answers the question based on his judgement. Both the methods are correct and does not affect core concept which asked by the examiner.

G. Answer: Reduction of Cost of Capital by 0.5% will increase the value of the firm as the discount rate by which cash flow ( in this case EBIT $1.3 million) is dicounted will reduce, thus increasing the value of the firm. Valuation is done using the Discounted Cash flow method.