Question

Devon Limited is a company that has issued corporate bonds with a par value of $100 and a coupon rate of 11%. The Total Statement of Financial Position value of bonds is $50million. The company’s bonds are currently trading at a price of $103. Interest is payable annually in arrears. The maturity date is in four years time. The company has a target capital structure of 25% debt, 15% redeemable preference shares, 10% non-redeemable preference shares, and 50% in ordinary equity financing. Retained earnings and contributed capital amount to $100million. The company has two types of preference shares in issue. There are 0.2 million non-redeemable preference shares which are issued at $100 per share and there are 0.3 million redeemable shares which were also issued at $100 and are redeemable at $100 per share. The maturity date of redeemable shares is in four years’ time. Preference dividends are payable annually in arrears for both issues. Non-redeemable preference shares are currently priced at $107 and the redeemable preference shares are currently priced at $104. The coupon rates are 9% for each issue and coupon payments were recently paid.The company’s beta is 1.20 and the risk free rate is 8%. The market premium is expected to be 5.5%. The corporation tax rate is 28%.

Required:

(a)What is Devon’s after tax cost of debt?

(b)What is the cost of the two types of preference shares?

(c)What is the cost of equity?

(d)What is the company’s weighted average cost of capital?

Answer 1