You have been hired as a financial consultant to a company for investigating the possibility of...
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You have been hired as a financial consultant to a company for investigating the possibility of investing in Telford Ltd, which is a taxation category 2 company. Your company has a required rate of return of 11% per annum and, as such, need to identify the rate of return demanded by the investors in Telford to compare to your company's required rate. You have identified the following characteristics of Telford. The latest financial information and balance sheet for Telford shows: Long Term Debt Bonds: Issued at par: $100 Annual coupon of 13% 6 years to maturity Book Value ($) 7,000,000 Equity Preference Shares: 2,000,000 200,000 shares outstanding Ordinary Shares: 6,000,000 6,000,000 shares outstanding The company's bank has advised that the interest rate on any new debt finance provided for new projects would be 10% p.a. The company's preference shares currently sell for $14.85 each and pay an annual dividend of $2.75. The company's existing ordinary shares currently sell for $1.25 each and pay a dividend per share of $0.25 which has just been paid to shareholders. Historically, dividends have increased at an annual rate of 6% p.a. and are expected to continue to do so in the future. Telford's company tax rate is 30%. REQUIRED: a) Determine the market value proportions of debt, preference shares and ordinary equity comprising the company's capital structure. b) Calculate the after-tax costs of capital for each source of finance. (12 marks) (5 marks) c) Determine the after-tax weighted average cost of capital for the company. (3 marks) d) How does the cost of debt capital relate to the value of a debt security? (4 marks) e) Based on your calculations determine whether it is a good idea (or not) to invest in Telford (3 marks) You have been hired as a financial consultant to a company for investigating the possibility of investing in Telford Ltd, which is a taxation category 2 company. Your company has a required rate of return of 11% per annum and, as such, need to identify the rate of return demanded by the investors in Telford to compare to your company's required rate. You have identified the following characteristics of Telford. The latest financial information and balance sheet for Telford shows: Long Term Debt Bonds: Issued at par: $100 Annual coupon of 13% 6 years to maturity Book Value ($) 7,000,000 Equity Preference Shares: 2,000,000 200,000 shares outstanding Ordinary Shares: 6,000,000 6,000,000 shares outstanding The company's bank has advised that the interest rate on any new debt finance provided for new projects would be 10% p.a. The company's preference shares currently sell for $14.85 each and pay an annual dividend of $2.75. The company's existing ordinary shares currently sell for $1.25 each and pay a dividend per share of $0.25 which has just been paid to shareholders. Historically, dividends have increased at an annual rate of 6% p.a. and are expected to continue to do so in the future. Telford's company tax rate is 30%. REQUIRED: a) Determine the market value proportions of debt, preference shares and ordinary equity comprising the company's capital structure. b) Calculate the after-tax costs of capital for each source of finance. (12 marks) (5 marks) c) Determine the after-tax weighted average cost of capital for the company. (3 marks) d) How does the cost of debt capital relate to the value of a debt security? (4 marks) e) Based on your calculations determine whether it is a good idea (or not) to invest in Telford (3 marks)
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Answer rating: 100% (QA)
a Market Value Proportions of Capital Structure Debt Since the current market value of bonds is not provided we cannot directly calculate the debt pro... View the full answer
Related Book For
Fundamentals of Corporate Finance
ISBN: 978-0077861629
8th Edition
Authors: Stephen A. Ross, Randolph W. Westerfield, Bradford D.Jordan
Posted Date:
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