Your client wishes you to investigate a telecommunications company with the following balance sheet and details (below): Long-term debt $ Bonds: Par $1,000, annual coupon 7% p.a., 3 years to maturity 10,000,000 Equity Preference shares 5,000,000 Ordinary shares 15,000,000 Total 30,000,000.

Notes:

The company's bank has advised that the interest rate on any new debt finance provided for the projects would be 6% p.a. if the debt issue is of similar risk and of the same time to maturity and coupon rate.

There are currently 1,000,000 preference shares on issue, which pay a dividend of $0.75 per share. The preference shares currently sell for $5.89.

The company's existing 5,000,000 ordinary shares currently sell for $2.34 each. You have identified that the company has recently paid a $0.35 dividend. Historically, dividends have increased at an annual rate of 2% p.a. and are expected to continue to do so in the future.

The company's tax rate is 30%.

Your client wishes to understand, with the use of workings, the following aspects of this company and states that their required rate of return for investment in a company with similar characteristics to this particular company would be 10% p.a.

Advise the client on whether you believe this to be a good or bad investment and the rationale for investment (or not investing).

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.

c) Determine the after-tax weighted average cost of capital for the company.

d) Indicate, using all applicable information, whether you would recommend this telecommunications company to your client (or not).

Answer rating: 100% (QA)

a To determine the market value proportions of debt preference shares and ordinary equity comprising the companys capital structure we need to calculate the market value ... View the full answer