Question

Part B Cost of Capital (Show all workings ) Grainwaves Ltd is an Australian firm which is publicly-listed on the ASX. The company has a long term target capital structure of 55% Ordinary Equity, 5% Preference Shares, and 40% Debt. All of the shareholders of Grainwaves are Australian residents for tax purposes. To fund a major expansion Grainwaves Ltd needs to raise a $150 million in capital from debt and equity markets. Grainwaves Ltd’s broker advises that they can sell new 10 year corporate bonds to investors for $105 with an annual coupon of 6% and a face value of $100. Issue costs on this new debt is expected to be 1% of face value. The firm can also issue new $100 preference shares which will pay a dividend of $7.50 and have issue costs of 2%. The company also plans to issue new Ordinary Shares at an issue cost of 2.5%. The ordinary shares of Grainwaves are currently trading at $4.50 per share and will pay a dividend of $0.15 this year. Ordinary dividends in Grainwaves are predicted to grow at a constant rate of 7% pa. i. Calculate how much debt Grainwaves will need to issue to maintain its target capital structure. ii. What will be the appropriate cost of debt for Grainwaves. iii. Calculate how much Preference Share equity Grainwaves will need to issue to maintain their target capital structure. iv. What will be the appropriate cost of Preference shares for Grainwaves? v. Calculate how much Ordinary Share equity Grainwaves will need to issue to maintain their target capital structure. vi. What will be the appropriate cost of Ordinary Equity shares for Grainwaves? vii. Calculate how the Weighted Average Cost of Capital for Grainwaves Ltd following the new capital raising. viii. Grainwaves Ltd has a current EBIT of $1.3 million per annum. The CFO approaches the Board and advises them that they have devised a strategy which will lower the company’s cost of capital by 0.5%. How will this change the value of the company? Support your answer using theory and calculations.

Answer 1