Question

Cendana Berhad has made a profit of RM3 million last year. From those earnings, the company paid the dividend of RM2.00 on each of its 1,000,000 common shares outstanding. The capital structure of the company includes 30% debt, 20% preferred shares and 50% common shares. The corporate tax rate is 28%. The company wishes to venture into a new project and decided to use debt, preferred shares and common shares as sources of financing and still maintaining its current capital structure ratio. Based on the following information, calculate the weighted average cost of capital (WACC) of the company for taking the new project.

You are required to calculate:

i.         The market price of its common share is RM12 and dividend are expected to grow at constant rate of 6% and flotation costs on its new common shares are RM1.50 per share.

ii) The company can issue 3% dividend preferred shares at a market price of RM10 per share and flotation cost of RM1.00 per share.

iii.       The company can issue 7%, 5 years bonds that can be sold for RM1, 100 each in the market and flotation cost of RM5 per bond.

  

iv. WACC for taking the new project :

                                                                                                                         

                     

Answer 1

Flotation Costs (%) = Flotation Cost (amount) / Market price or issue price

Cost of Equity (with flotation costs)
= {D₁ / [P₀ * (1 - Flotation Costs in %)]} + G
= 27.4%
where
D₁ = Dividend next year [D₀ * (1+G)]
P₀ = Current Market Price or Issue Price
G = Constant Growth Rate

Cost of Debt (with Flotation Costs)

Pre-Tax Cost of Debt = YTM = 4.82%
(Price of the bond - Flotation Costs) = Coupon₁/(1+YTM)¹ + Coupon₂/(1+YTM)² + ..... + (Coupon_n + Face Value)/(1+YTM)ⁿ

After-Tax Cost of Debt = Pre-Tax Cost of debt * (1-Corporate Tax) = 3.47%

Cost of Preferred Equity (with flotation costs)

= D / [P₀ * (1 - Flotation costs in %)]
= 3.33%
where
D₁ = Dividend
P₀ = Current Market price or Issue Price

WACC
= (Cost of Equity * Weightage of Equity) + (after-tax cost of debt * Weightage of Debt) + (Cost of Preferred Equity * Weightage of Preferred Equity)
= 15.41%

Note:- Since, the face value of preferred stock is not given, I have assumed it to be 10