Gina Wang has a large pile of reports, prepared by her finance division, with details of various options to fund a new venture. Gina is the CEO of Eastern Logistics and has been running the company for five years. The business has been great, thanks to growing trade relations between China and Europe in recent times. The business had been renting two warehouses, one in France and one in the United Kingdom, to manage its European distribution. The directors plan to modernize the distribution infrastructure by adding a new custom-built warehouse that can halve the loading and unloading time of its freight trucks. The new warehouse project requires an investment of €60 million. Gina has prepared the following summary of planned finance sources for the new venture:

 

The current market price of an ordinary share is €30, and it paid dividends of €2.70 last year. The dividends are expected to grow by 9 percent annually. Eastern Logistics has a credit rating of AAB. Currently, the AAB bonds are yielding 8 percent. The preference shares have a market value of €150 per share. The corporate tax rate for Eastern Logistics is 30 percent.

a. What should be the weighted average cost of capital for Eastern Logistics for the new project? 

b. The investment bankers of Eastern Logistics have now sent a revised report including the floatation costs. It suggests that the term loan will require a floatation cost of 50 basis points and ordinary shares of 600 basis points, the preference shares will incur 250 basis points, and the bonds will incur 100 basis points of floatation costs. What are the total floatation costs the firm will incur to raise the required capital of €60 million? 

c. How can we incorporate the floatation costs into the overall analysis of the cost of capital for this project for Eastern Logistics?

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Types of Financing Bonds Ordinary Shares Term Loan Preference Shares Details Percentage of Total Capital 10%, €100 face value, 20 year maturity 25% ΝΑ 40% 8% 10% Face Value of €200, paying dividend €15 25% per year Total 100% Types of Financing Bonds Ordinary Shares Term Loan Preference Shares Details Percentage of Total Capital 10%, €100 face value, 20 year maturity 25% ΝΑ 40% 8% 10% Face Value of €200, paying dividend €15 25% per year Total 100%

Answer rating: 100% (QA)

a The weighted average cost of capital for Eastern Logistics for the new project is 86 Wei... View the full answer