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Homework answers / question archive / a) Bella industry (Bella) is seeking your financial advice to determine the firm;s cost of capital

a) Bella industry (Bella) is seeking your financial advice to determine the firm;s cost of capital

Finance

a) Bella industry (Bella) is seeking your financial advice to determine the firm;s cost of capital. The following data is given to you

I) 20 years bond with 12% coupon was issued 10 years ago and is currently selling at RM1153.00. the firm's tax bracket is 40% and flotion cost is 20% of par value. The par value is RM1000.00
II) The current of its preferred stock is RM1.13 iissued with a divident of 10% of par value of Rm1. Flotation cost is 10% of its current price.
III) Bella's stock is currently selling at RM5 per share. The expected dividend for next year is RM0.44 and it is expected to grow ar a constant rate of 5%


Calculate the after tax cost of:
a) Debt
b) Preferred stock
c) Equity


b) Calculate the weighted average cost of capital (WACC) if the ratio is as follows:
a) debt 30%
b) Preferred stock 20%
c) Equity 50%

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Answer : (a) Calculation the after tax cost :

Calculation of Cost of after tax debt :

Using Financial Calculator

=RATE(nper,pmt,pv,fv)

where nper is Number of years remaining to maturity i.e 10years (20 - 10)

pmt is Interest payment i.e 1000 * 12% = 120

pv is Current Market Price

= [1153 - (1000 * 20%)]

= 953

Note : pv should be taken as negative.

fv is face value i.e 1000 (Assumed)

=RATE(10,120,-953,1000)

Before tax cost of Debt is 12.861%

After tax cost of Debt = Before tax cost of debt * (1 - Tax rate )

=12.861% * (1 - 0.40)

= 7.72%

Calculation of Cost of Preferred Stock

Cost of Preferred Stock = Annual Dividend / (Current Market Price - Flotation cost)

= [1 * 10%] / [1.13 - (1.13 * 10%)]

= 0.1 / 1.017

= 0.09832841691 or 9.83%

Calculation of Cost of Equity

Cost of Common Equity = [Expected Dividend / (Market Price )] + growth rate

= [0.44 / 5 ] + 0.05

= 0.138 or 13.8%

Calculation of WACC of the Firm

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

= (7.72% * 0.30) + (9.832841691% * 0.20) + (13.8% * 0.50)

= 2.32% + 1.97% + 6.9%

= 11.18%