Problem
ABC Limited has the following book value capital structure:
Equity share capital (150 million shares, Shs. 10 par) Shs. 1,500 million
Reserves and surplus Shs. 2,250 million
10.5% Preference Share Capital (1million shares, Shs. 100 par) Shs. 100 million
9.5% Debentures (1.5 million debentures, Shs, 1,000 par) Shs. 1,500 million
8.5% Term Loans from Financial Institutions Shs. 500 million
The debentures of ABC Limited are redeemable after three years and are quoting at Shs. 981.05 per debenture. The applicable income tax rate for the company is 35%.
The current market price per equity share is Shs. 60. The prevailing default -risk free interest rate on 10- year GOK Treasury Bonds is 5.5%. The average market risk premium is 8%. The beta of the company is 1.1875. The preferred stock of the company is redeemable after 5 years is currently selling at Shs. 98.15 per preference share.
Task
a) Calculate weighted average cost of capital of the company using market value weights.
b) Define the marginal cost of capital schedule for the firm if it raises Shs. 750 million for a new project. The firm plans to have a target debt to value ratio of 20%. The beta of new project is 1.4375. The debt capital will be raised through term loans. It will carry interest rate of 9.5% for the first 100 million and 10% for the next Shs. 50 million.