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Target Capital Structure and Future investments

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DC computer Ltd has recently changed its target capital structure and expects to maintain it for future investments. This target capital structure is reflected in the current market value of the financing already undertaken: $272,000 in debt, $428,000 in preference shares and $400,000 in ordinary equity. The following data has been collected to calculate the new weighted marginal cost of capital.

1) 100,000 ordinary shares have been issued with the current market price of $4.00. $40,000 in dividends was paid out this year. Dividends are expected to grow at the annual rate of 5%. To float this new issue the firm would have to offer a discount of 0.30c per share below market price. The cost of such an issue is expected to be 0.20c per share.
2) 100,000 preference shares issued with a current market price of $4.28 each with dividends of 0.50c per share. Issue cost for preference shares is 2% of the market price.
3) The cost of debt (before tax and after issue costs) has been calculated as 12.72% pa. The firm's tax rate is 30%.
Required
a) Calculate the weighted average cost of capital (WACC), which includes the cost of newly issued ordinary and preference share.
b) Discuss how much influence Financial Managers should put on the WACC.
c) How does the WACC compare to the SML and when should each be used.

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Solution Preview

Please see the attached file.

Yes you are correct, here we need to take the expected dividend per share. Expected dividend per share= Dividend *(1+growth rate)
=0.4*(1+5%)
=0.42
Hence Revised ...

Solution Summary

Solution helps in calculating the new weighted marginal cost of capital.

$2.19
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