Reference no: EM133104698
Question - Doors Ltd is a company that produces and sells welcome mats through a network of retail outlets. Company management has decided that the company also needs an online presence and wants to raise capital to create a high quality online store and build warehouses for distribution purposes. Currently, the company has R200 million in debt, R400 million in assets and R100 million of its equity is comprised of retained earnings in the form of cash holdings, which management wishes to use before it issues new debt. The management of the company indicated that they wish only to raise equity by way of a rights issue, after having issued the maximum amount of bonds.
The company requires R200 million in capital for its expansion plans, which will be raised as per the guidelines from management. The company can obtain capital as follows:
Up to 5000, ten year, R10 000 par value, 15% annual coupon (paid at the end of each year), bonds can be issued at R9 000 per bond.
Up to 2 million shares can be issued in a renounceable rights issue at a subscription price of R40 each (ignore any issuance or transaction costs). The current market price of the company's shares is R50; and it is expected that 50% of existing shareholders will exercise their rights and that the remainder will transfer their rights to a third party. There are currently 1 million shares in issue.
Assume that the company has an unlevered beta of 1,00 under its current capital structure; is taxed at a rate of 28%; and that issuance and transaction costs are negligible. The risk-free rate is 8% and the market risk premium 6%. The company has a target debt to equity ratio (D/E ratio) of 1,00 (or a debt ratio of 50%).
Required -
a) Determine how much capital the company will need to raise from each source of financing (if at all).
b) Calculate the cost of each source of financing.
c) Determine the weighted average cost of capital (WACC) for the company.
d) Discuss the new WACC of the company, the financial risk profile of the company and how control of the company may be affected (show your calculations regarding control).