Question

Shelll is currently measuring its cost of capital for purchasing a piece of land for its future R&D center. The center is located in the middle of Geneva. The management has the following financing options:

Shell can raise its capital by selling 20 years, U$D1,000 par-value, 6 percent coupon interest rate bonds that pay semi-annual interest. Floatation cost is 5 percent on the selling price of U$D980.

Shell can issue a 10 percent, U$D100 par value, preferred stock that price at U$D109.10. The floatation cost involves in issuing new preferred stock is U$D5 per stock.

The firm’s common share is currently trading at U$D43.20 per share. Its last dividend was U$D3.60 and dividends are expected to grow at a constant rate of 5% in the foreseeable future. Any new equity issuance will be underpriced by U$D0.30 per share and will incur floatation costs of U$D0.20 per share.

The firm expects to have U$D5,000,000 of retained earnings available in the coming year. Once the retained earnings are exhausted, the firm will use a new common share as the form of common equity financing. All companies in Malaysia are required to pay 28 percent of corporate tax. You are required to:

1. Formulate the weighted average cost of capital (WACC) using its internal funds. The appropriate capital structure for shell would be 55 percent of debts, 15 percent of preferred stock, and the remaining through issuing common stock.

2. Measure the company’s WACC if the company’s retained earnings are insufficient to support the expansion.

3. Discuss FIVE (5) factors that firms have to consider in establishing a dividend policy.   

Answer 1