Matro, a public limited company, has decided to launch a new flour brand with the name of “A1 Flour”. The shares of the Matro are selling in stock exchange at Rs. 65 and it has just paid the dividend of Rs. 6.5 which is expected to grow at 7%. The aggregate market return is expected to be 14% and treasury securities are yielding 7%. It has also Rs. 100 par 8.5 % preferred stock outstanding that is currently selling at Rs. 73. Metro is paying 14% interest of its bonds and has also obtained bank loan at 14%. The risk analysis shows that the beta of the company is 1.7000000000000004.

The capital Structure of Metro consists of:

Fund Source	Rate	Market Value	Weight
Equity		5,000,000	50%
Preference shares	8.5%	2,000,000	20%
Bonds	14%	2,000,000	10%
Bank Loan	14%	1,000,000	20%
Total		10,000,000

The new venture requires of an import of equipment from UK at the cost of Rs.1,700,000. Further it will cost the company Rs. 480,000 for shipping charges, installation and testing the equipment etc. There will be an increase of Rs. 920,000 in working capital if the company starts this project. The operating profit excluding the tax depreciation is expected to be:

Year	Cash Flows
1	Rs. 820,000
2	Rs. 920,000
3	Rs. 970,000
4	Rs. 1,020,000
5	Rs. 1,070,000
6	Rs. 1,220,000

The tax authorities have allowed depreciating the asset in first 4 years through straight line method. The tax rate is 39%. At the end of the project the additional working capital will be released and the equipment may be sold for Rs. 430,000.

Required:

1. Find out after tax cost of bond and bank loan. (Marks 2 + 2 = 4)
2. Find out the cost of preference shares. (Marks 3)
3. Find out the cost of equity assuming that CAPM is the best approach to find out the cost of equity. (Marks 3)
4. Find out the cost of equity assuming that Dividend Growth Model is the best approach to find out the cost of equity. (Marks 3)
5. Calculate the weighted average cost of capital assuming that Dividend Growth Model is the best approach to find out the cost of equity. (Marks 5)
6. Calculate the initial cash outflow, incremental cash flows and terminal year cash flows. (please do not get confused, you need to calculate the incremental cash flows as the above table is showing the operating profit without depreciation) (Marks 2 + 7 + 3 = 12)
7. Calculate the payback period. (Marks 3)
8. Calculate the NPV, will the new project worthwhile. (Marks 5)
9. What is the IRR of the project? (Marks 5)
10. Calculate the Profitability Index (Marks 2)

Answer rating: 100% (QA)

Matro Ans 1 Tax Rate T39 Interest Rate on Bond 14 After Tax cost of Bond 141T14139854 Interest Rate on Bank Loan 14 After Tax cost of Bank Loan 141T17139854 Ans 2 Par Value of Preference share Rs 100 ... View the full answer