Reference no: EM132740136

Big Shot of Toora Incorporations.

Toora is interested in measuring its specific and overall cost of capital because the company is willing to find out competitive advantage by this means. Current investigation has gathered the following data about the available financing options.

The Company can raise an unlimited amount by issuing 12% debentures of Rs. 1,000 par value at Rs. 50 premium with Rs. 10 floatation cost. The debenture will pay Annual interest for 5 years. The firm can also sell 10% (annual dividend) preferred stock at Rs. 110 with Rs. 100 par value. The cost of issuing and selling the preferred stock is expected to be Rs. 4 per share. An unlimited amount of preferred stock can be sold under these terms. The firm's common stock is also an option and currently selling for Rs. 90 per share in quoted market, par value of common stock is Rs. 100. The firm expects to pay cash dividends of 8% per share next year. The firm's dividends have been growing at an annual rate of 5%, and this rate is expected to continue in the future. The stock will have to be overpriced by Rs. 4 per share in current issuance to general public, and

flotation costs are expected to amount to Rs. 2 per share. The firm can sell an unlimited amount of new common stock under these terms. The firm expects to have Rs. 400,000 of retained earnings available in the coming year. Once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.

A. Calculate the specific cost of each source of financing with assumption 40% tax bracket.

B. The firm uses the weights shown in the following table, which are based on target capital structure proportions, to calculate its weighted average cost of capital.

Capital Mix 1 Weight Capital Mix 2 Weight

Long-term debt 40% Long-term debt 40%

Preferred stock 15% Preferred stock 15%

Shares equity or R/E 45 Shares equity 25%

Retained Earning 20%

1. Calculate the single break point associated with the firm's financial situation.

2. Calculate WACC below break point with R/E (Capital mix 1) only & above break point

with both of the composition, use only New shares (Capital Mix 1) as common equity and

combination of R/E & New shares (Capital Mix 2) as common equity.

C. Take the data from part A & B, Calculate WMCC and suggest the company about all feasible

options among available below.

Investment Opportunity Internal rate of return Initial Investment

A 11.2% Rs. 400,000

B 19.7 50,000

C 12.9 150,000

D 10.0 200,000

E 11.8 450,000

F 10.1 600,000

G 10.5 300,000