Reference no: EM133180096

Question - You have just started working in the finance department of Anderson and McArthur Limited. Your first task is to restate the long-term finance component of the following balance -sheet extract to reflect market values:

Bonds ($1000, 8% annual coupon, 30-year maturity): $150 million

Ordinary shares (100 million issued): $100 million

Once you have completed this, you have to review the evaluation of a proposal for a major equipment investment. You have ascertained that the evaluation has been completed using estimates provided by the company's operational staff of the projects' incremental cash flows and the directive from the company's managing director that 100% of the funds for this project will be provided by retained earnings. You remember from your job interview that John Sanderson, the company's managing director, told you that 'he knows everything about finance' and that as retained earnings are a costless source of finance he can maximise the NPV of a project by funding all the initial investment with retained earnings.

1. If the current yield on the company's bonds is 7% p.a. and the current market price of its ordinary shares is $3.5, determine the current market-value weights of the company's capital structure.

2. Why do you need to calculate the market-value weights of the long-term debt and equity?

3. Are retained earnings a costless of ordinary equity finance?

4. Should the weighted average cost of capital be used to evaluate this project?

5. The company is subject to a classical tax system at a marginal tax rate of 28%. Also, the company recently paid an ordinary dividend of 34 cents per share and future dividend amounts are expected to grow at an annual rate of 4%. Calculate the company's after-tax weighted average cost of capital.