Financial Management $11$ Course Work No$\mathrm{.}1$

Question No$\mathrm{.}1$

You are an investment analyst. The managing director of Cashmere Investment Ltd has ask you to assess the capital structure of the firm and has provided the following information:

Preferred Stock:

$100000$ shares of $12\%$ preferred stock issued at $$120\mathrm{.}00$ per share. Current market price is

$$160$ per share.

Common Stock:

$250000$ shares outstanding, selling for $$110$ per share. The current risk rate is $12\%$ and

the stock$$s beta is $1\mathrm{.}15.$ The expected rate of return on the average stock in the market is $16\%.$

Debt

The firm can borrow funds at $15\%$ interest per year. Assume that the tax rate is $25\%.$

Required

a$.$ Using the information above to calculate the firm$$s WACC if the target capital structure comprises $40\%$ debt, $20\%$ preferred stock and $40\%$ common stock. $[12$ marks$]$

b$.$ If the beta of the stock was $1\mathrm{.}95$ and the firm$$s capital structure was modified to $40\%$ debt, $10\%$ preferred stock, and $50\%$ common, what is the firm$$s new WACC? $[8$ marks$]$

c$.$ The firm is expected to pay a year$-$end dividend of $$25\mathrm{.}00$ per share at year end and its flotation cost is $5\%.$ Investors have projected an expected growth rate of $15\%$ per annum.

i$.$ What is the cost of retained earnings using the discounted cash flow approach $($Gordon Growth model$)?$

$[3$ marks$]$

ii$.$ Calculate the cost of issuing new common stock. $[3$ marks$]$

d $.$ Why is the cost of capital measured on an after$-$tax basis? Why is the use of a weighted average cost rather than the cost of specific funds recommended? $[4$ marks$]$

$[$Total $30$ marks$]$