Universe Corporation wishes to compute a weighted average cost of capital for use in evaluating capital expenditure proposals. Earnings. capital structure and the current market price of the company s securities are:

EARNINGS:

Earnings before interest and income tax 210,000

Interest expense in bonds 30,000

Pre-tax earnings 180,000

Income tax (45% tax rate) 81,000

After-tax earnings of 99,000

Preference share dividends 24,000

Earnings available to ordinary shareholders 75,000

Ordinary share dividends 30,000

Increase in retained earnings 45,000

CAPITAL STRUCTURE:

Mortgage bonds. 10%, 10 years 300,000

Preference share. 12%, P100 par value 200,000

Ordinary share, no par,

50,000 shares outstanding 350,000

Retained earnings

(equity of ordinary shareholders) 150,000

1,000,000

MARKET PRICES OF THE COMPANY S SECURITIES:

Preference share P96

Ordinary share 10

Bonds 105

Required:

1. Determine the weighted average cost of capital. (5 pts)

2. Using your computed weighted average cost of capital in number 1 above, decide whether the following proposed investment proposals, given their expected return on investment, would be accepted? (6 pts)

Proposed Investment

ROI

Advice (Accept or Reject?)

India

7%

?

Mexico

10%

?

Peru

14%

?

Answer rating: 100% (QA)

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