The directors of M Co are considering opening a new factory tomanufacture a new product at...

 

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The directors of M Co are considering opening a new factory tomanufacture a new product at a cost of $3.0 million. During the last 5years, the company has had 3 million shares in issue. The current marketprice of these shares (at 31 December 20X8) is $1.45 ex-dividend. The company pays only one dividend each year (on 31 December) and dividends for the last five years have been as follows: Year 20X8 20X7 20X6 20X5 20X4 Dividend per share (cents) 14.1 14.1 12.1 11.6 11.0 M Co currently has in issue $1 million 7% debentures redeemable on31 December 20Y2 at par. The current market price of these debentures is$83.60 ex-interest, and the interest is payable in one amount each yearon 31 December. The company also has outstanding a $500,000 bank loanrepayable on 31 December 2017. The rate of interest on this loan isvariable, being fixed at 3% above the bank's base rate which is currently 5%. Required: (a) Calculate the weighted average cost of capital (WACC) for M Co as at 31 December 20X8 (15 marks) (b) Explain the terms business riskand financial risk and the significance of each in using an existingWACC to appraise a future project. (7 marks) (c) Briefly advise the directors of MCo on the suitability of using the WACC calculated in (a) above todiscount the expected cash flows of the project The directors of M Co are considering opening a new factory tomanufacture a new product at a cost of $3.0 million. During the last 5years, the company has had 3 million shares in issue. The current marketprice of these shares (at 31 December 20X8) is $1.45 ex-dividend. The company pays only one dividend each year (on 31 December) and dividends for the last five years have been as follows: Year 20X8 20X7 20X6 20X5 20X4 Dividend per share (cents) 14.1 14.1 12.1 11.6 11.0 M Co currently has in issue $1 million 7% debentures redeemable on31 December 20Y2 at par. The current market price of these debentures is$83.60 ex-interest, and the interest is payable in one amount each yearon 31 December. The company also has outstanding a $500,000 bank loanrepayable on 31 December 2017. The rate of interest on this loan isvariable, being fixed at 3% above the bank's base rate which is currently 5%. Required: (a) Calculate the weighted average cost of capital (WACC) for M Co as at 31 December 20X8 (15 marks) (b) Explain the terms business riskand financial risk and the significance of each in using an existingWACC to appraise a future project. (7 marks) (c) Briefly advise the directors of MCo on the suitability of using the WACC calculated in (a) above todiscount the expected cash flows of the project

Answer rating: 100% (QA)

a Weight ed average cost of capital W ACC for M Co as at 31 December 20 X 8 The W ACC for M Co as at 31 December 20 X 8 can be calculated using the fo... View the full answer