Reference no: EM133025816

QUESTION - A company in Johor, R.E. Batt Co. is specializing in manufacturing special battery for hybrid cars. It is considering to build another manufacturing plant costing RM20 million as an expansion to the business as market for electric vehicles is anticipated to grow immensely. The new plant is expected to generate after-tax cash flows of RM5 million in perpetuity.

The tax rate of the firm is currently at 25%. The following information and data are available:

Source of capital RM

Long term debt 5,000,000

Preferred shares 50,000

Common shares 2.350,000

Issue common shares. The price of the existing shares of the company is RM25. The expected dividend for next year is RM2.20 and the growth rate will remain at 6 percent. The floatation cost is RM3 per share. R.E. Batt Co. will be selling the shares under these terms.

Issue 20-year shariah-compliant RM1000 par value bonds. The floatation cost of the new bonds would be 5 percent of the proceeds. R.E.Batt Co. will sell the bond at a discount of RM3 and these new bonds have an annually profit sharing rate of 8 percent coupon rate.

Issue preferred share. The security has a par value of RM100 per share, where the annual dividend rate is 5 percent of the par value, floatation cost is expected to be RM4 per share. The share can be sold for RM103.

Retained earnings. R.E.Batt Co. has an available RM250,000 of retained earnings in the coming year. It is noted that once these retained earnings are exhausted, the firm will use new common shares as the form or equity financing. (The company may disregard the cost of brokerage and tax bracket for the calculation of this cost)

The board member would like to know the weighted average cost of capital (WACC) for R.E. Batt Co. before making their final decision. As the CFO of R.E.Batt Co., prepare the following for presentation in the next Board meeting.

a) Calculate the company's WACC using retained earnings and the capital structure weights shown in the table above.

b) Calculate the company's WACC using new issuance of common shares and the capital structure weights shown in the table above.

c) Comment on the company's overall decision.