Question

A]Define the cost of Capital and what rote dose if play in the firm's long term investment decisoins?

by Zaraton Company is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The firm is a 40% tax bracket Debt The firm can raise debt by selling RM1.000 par values.coupon rate, 20 years bond on which annual Interest payment will be made. To set the issue, on average discount of RM20 per bond would have 10 be given. The firm maloso pay notation costs of of the par value Preferred stock the firm can set preleted stock at its RMS per hore pat value. The stock will pay an RB.DO annua dividend. The cost of issuing and selling the proforca stock is cxpectod to be RM3 pet share. Prefented stock can be sold under these terms D Common stock That's common stock is currently soling for RM40 por shoro Thoirm expects to pay cash dderds of RM5.07 per share next years. The firm's dividends nave been growing at an arewa rate of 9.45 and this growth is expected to continue Into the future. The stock must be underpriced by RMI pervice and clation couts are compacted to annount to RM per share. The firm can sol now common stock under these terms Calculate the after-sax coat of debt. (1.5 mars R. Calculate the cost of proferrod stock 11. marts 11 Calculate the cost of common stock (15 more) iv. Ceniculate the WACC for Zaratan Company in the firm has exhausted cal retained ecoming The weighted average costs to be measured by using the toucwing weights: 30long-term debt, preferred



[Hint provide with explanation ,formulas  and solutions]

Answer 1

A)

Cost of capital is the required return necessary to make a capital budgeting project, such as building a new factory, worthwhile. When analysts and investors discuss the cost of capital, they typically mean the weighted average of a firm's cost of debt and cost of equity blended together. The cost of capital metric is used by companies internally to judge whether a capital project is worth the expenditure of resources, and by investors who use it to determine whether an investment is worth the risk compared to the return. The cost of capital depends on the mode of financing used. It refers to the cost of equity if the business is financed solely through equity, or to the cost of debt if it is financed solely through debt.

(i) After tax cost of debts = Interest *( 1-tax ) = 9% * (1-0.4) = 5.4%

(ii) Cost of Preference Stock = Kp = D/ Np
D = Dividend per share = RM 8.00
Np = Net Proceeds = Par value of each share - Discount (if any) - Cost of Floatation = RM 65.00 - RM 3.00
= RM 62.00
Cost of Preference Share = Kp = 8.00/ 62.00 * 100 = 12.90%

(iii) Cost of Equity Shares = DPS​ +GRD
CMV
DPS = Dividend per share for the next year = RM 5.07
CMV = Current Market Value = RM 40.00
GRD = Growth Rate of Dividends = 9.40% = 0.094

It is also mentioned that the shares are to be underpriced by RM 1.00 and the floatation costs are RM 1.00
Adjusted CMV = RM 40.00 - RM 1.00 - RM 1.00 = RM 38.00

Cost of Equity Shares = 5. 07 + 0.094
38.00
= 22.74%

(iv) Weighted average cost of Capital = ( 30%* Kd ) + ( 5%*Kp ) + ( 65%*Ke )
=(30% * 5.4%) + (5%* 12.90%) + (65%*22.74%)
= 1.62% + 0.65% + 14.78%
WACC = 17.05%

As HOMEWORKLIB RULES answering rules, we are expected to answer only the first 4 questions; hence I am answering untill this point. If you need further details, put them as comments please.
Excuse me on that.