Question

Northland Mining” is considering a major Coal mine project in North Queensland, Australia. Costs of financing have been declining recently, and the company’s finance department is considering sourcing the capital through debt and equity.

Northland Mining’s bonds will mature in four years with a total face value of $80 million, paying a half yearly coupon rate of 10% per annum. The yield on the bonds is 15% per annum.

The market value for the company’s preference share is $6.50 per unit while the ordinary share is currently worth $1.90 per unit. The preference share pays a dividend of $1.10 per share. The beta coefficient for the ordinary share is 1.4. The market risk premium is estimated to be 10% per annum and the risk-free rate is 4% per annum.

The company is subject to a 30% corporate tax rate.

Below is the recent balance sheet for the company:

Debt:

Bonds: $80 million

Equity:

Preference Shares (100,000 units): $4 million

Ordinary Shares (10 million): $14 million   

(a) Calculate the after-tax cost of each of the company’s current financing sources listed below:

(i). Bonds [2 marks]

(ii). Preference shares [2 marks]

(iii). Ordinary shares [2 marks]

(b) Using the information provided above, calculate the market values for the financing sources listed below:

(i). Bonds [2 marks]

(ii). Preference shares [2 marks]

(iii). Ordinary shares [2 marks]

(c) Using the information from the previous sections, calculate the company’s after-tax weighted average cost of capital (WACC). [4 marks]

(d) The finance manager of Northland Mining has identified a potential project with an IRR of 18% per year. Should this project be undertaken by the company? Discuss your recommendation using relevant calculations. [4 marks]

Answer 1