Reference no: EM133178767
Question - Your client wishes you to investigate an agricultural company with the following balance sheet and details (below):
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Long-Term Debt
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$
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Bonds: Par $100, coupon rate 6% p.a., 8 years to maturity
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5,000,000
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Equity
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Preference shares
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4,000,000
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Ordinary shares
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9,000,000
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The company's bank has advised that the interest rate on any new debt finance provided for the projects would be 7% p.a. if the debt issue is of similar risk and of the same time to maturity and coupon rate.
There are currently 4,000,000 preference shares on issue, which pay a dividend of $0.75 per share. The preference shares currently sell for $2.69.
The company's existing 4,500,000 ordinary shares currently sell for $2.53 each. You have identified that the company has recently paid a $0.45 dividend, per share. Historically, dividends have increased at an annual rate of 2% p.a. and are expected to continue to do so in the future.
The company's tax rate is 30%.
Your client wishes to understand, with the use of workings, the following aspects of this company and states that their required rate of return for investment in a company with similar characteristics to this particular company would be 13% p.a.
Your task is to advise the client on whether you believe this to be a good or bad investment and the rationale for investing (or not investing).
You should proceed as follows:
a) Determine the market value proportions of debt, preference shares and ordinary equity comprising the company's capital structure.
b) Calculate the after-tax costs of capital for each source of finance.
c) Determine the after-tax weighted average cost of capital for the company.
d) Indicate, giving reasons based on all applicable information, whether you would recommend this biotechnology company to your client (or not).
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