Question

QUESTION 1 ( 15 MARKS) Cendana Berhad has made a profit of RM3 million last year. From those earnings, the company paid the dividend of RM2.00 on each of its 1,000,000 common shares outstanding. The capital structure of the company includes 30% debt, 20% preferred shares and 50% common shares. The corporate tax rate is 28%. The company wishes to venture into a new project and decided to use debt, preferred shares and common shares as sources of financing and still maintaining its current capital structure ratio. Based on the following information, calculate the weighted average cost of capital (WACC) of the company for taking the new project. You are required to calculate: i. The market price of its common share is RM12 and dividend are expected to grow at constant rate of 6% and flotation costs on its new common shares are RM1.50 per share. (3marks)

ii. The company can issue 3% dividend preferred shares at a market price of RM10 per share and flotation cost of RM1.00 per share. (3marks)

iii. The company can issue 7%, 5 years bonds that can be sold for RM1, 100 each in the market and flotation cost of RM5 per bond. (3marks)

iv. WACC for taking the new project : (6marks)

Answer 1

i) Cost of equity = dividend (1+growth rate) /( price - floatation cost) + growth rate

= 2 (1+0.6) / (12 - 1.5) + 0.06

= 2.12 / 10.5 + 0.06

= 0.2019 + 0.06

= 0.2619 or 26.19%

ii) Cost of preference share = annual dividend / price of share - floatation cost

= 3% × 10 / 10 - 1

= 0.3 / 9

= 3.33%

iii) Using financial calculator to calculate the ytm of bond

Inputs: N= 5

Pv= 1,100 - 5 = -1,095

Pmt= 7% × 1,000 = 70

Fv= 1,000

I/y = compute

We get, ytm of the bond as 4.82%

After tax cost of debt = 4.82% × (1-0.28)

= 4.82% (0.72)

= 3.47%

iv) WACC= weight of debt × after tax cost of debt + weight of preference share × cost of preference share + weight of equity × cost of equity

= 0.30 × 3.47% + 0.20 × 3.33% + 0.50 × 26.19%

= 1.04% + 0.667% + 13.095%

= 14.80%