Answer this Question:

Assess the CHP’s Weighted Average Cost of Capital (WACC) using the data in Exhibit
1. Your assessment shall include:
Cost of debt, Cost of preference share, Cost of ordinary share using CAPM, DCF, and Own-Bond Yield-Plus-Risk
Premium, and Weighted Average Cost of Capital (WACC)
 

CHP'S WEIGHTED AVERAGE COST OF CAPITAL (WACC) Muhammad plans to use the financial data in Exhibit 1 to estimate the WACC. When CHP started evaluating the project, the following conversation took place between Muhammad and Abdullah. Abdullah, the company's General Manager, is a UM graduate majoring in financial economics and has long years of administrative experience. Muhammad: It may not be easy to estimate the cost of borrowing in the current recessionary environment. Abdullah: Muhammad: Do you think the company's current market value capital structure is optimal? Can we use the current percentages of the capital components as weights in calculating the company's WACC? Abdullah: We can determine the yield to maturity (YTM) on our outstanding bonds by using their current market prices. We can assume that we will be able to issue additional bonds with this YTM at the cost of borrowing. We should be able to place the new bonds without any flotation costs. Therefore, we can assume no flotation costs in our calculations. We can re-examine the project's feasibility before raising funds by using sensitivity analysis to assess the impact of possible changes in interest rates on the project's net present value. Abdullah: Yes, I believe that the company's current market value capital structure of 40% debt, 10% preferred stock, and 50% equity is optimal. If the trial project success, we need about RM720,000 investment for all the branches. Currently, we have about RM160,000 in retained earnings this year, which is also available in cash. We should be able to use this year's retained earnings to finance part of the equity financing required for the project. However, we will have to issue some new ordinary shares for the remainder of the necessary equity financing. We can assume a flotation cost of about 5% for the new ordinary shares. Muhammad: There are three basic methods of calculating a firm's cost of equity when retained earnings are used as equity capital: 1) the capital asset pricing method (CAPM); 2) the discounted cash flow (DCF) approach; and, 3) the bond-yield-plus-risk-premium method. Which of these methods should we use in the calculation of our cost of retained earnings? Although each of these methods has its merits, I believe that the most appropriate approach for our company would be to find an average cost with the three methods.