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 :

       

                     (6marks)

Answer 1

Answer : (i.) Calculation of Cost of Common Stock :

Cost of Common Stock = [Expected Dividend / (Market Price - flotation cost) + growth rate

= [2 * (1 + 0.06) / (12 - 1.50)] + 0.06

= [ 2.12 / 10.5 ] + 0.06

= 0.2619047619 or 26.19%

(ii.) Calculation of Cost of Preferred Stock

Cost of Preferred Stock = [Dividend / (Current market Price - Flotation cost) ] * 100

= [(3% * 10) / (10 - 1)] * 100

= [0.3 / 9 ] * 100

= 3.333%

(iii.) Calculation of After tax cost of Debt

Using Rate function of Excel :

=RATE(nper,pmt,pv,fv)

where

nper is the years to maturity i.e 5

pmt is the coupon payment i.e 1000 * 7% = 70

pv is 1095 (Current Market Price - Flotation cost)

fv is 1000

=RATE(5,70,-1095,1000)

The Before tax cost of debt is 4.816838%

After tax cost of Debt = 4.816838% * (1 - 0.28)

= 3.47%

(iv) Calculation of WACC of the Firm

WACC = (Cost of After tax Debt * Weight of Debt) + (Cost of Preferred Stock * Weight of Preferred Stock) + (Cost of Equity * Weight of Equity)

= (3.47% * 0.30) + (3.33% * 0.20) + (26.19% * 0.50)

= 1.04% + 0.667% + 13.0952%

= 14.80%