As a financial analyst for JA60 Ltd, you have been given the assignment of determining the companys
Question:
As a financial analyst for JA60 Ltd, you have been given the assignment of determining the company’s cost of capital. Toward that end, the following
information has been collected:
Present Capital Structure | |||
Source of Capital | Par/Maturity Value | Total Book Value | Market Value |
Debt (8%, 15 years) | $1,000 | $8,000,000.00 | $1,200 per bond |
Preferred stock (8%) | $100 | $2,000,000.00 | $120 per share |
Common stock | $10 | $10,000,000.00 | $20 per share |
The company’s last common dividend was $0.97. The year before that, a dividend of $0.91 was paid. The growth rate for dividends is expected to be constant for the foreseeable future. The company’s tax rate is 35%.
a. Determine the weighted average cost of capital using market-value weights
b. The directors of JN60 have been told that they can reduce the overall cost of capital by issuing more long-term debt. Write a memo (in good form) outlining the extent to which increasing the gearing of the company could have the desired effect.
Note: State all formulas. All currency and percentage symbols should be shown. Show answers to 2dp. Marks will be awarded for expression. Responses to part (b) should show a similarity index of no more than 10%.