Reference no: EM133027313

Problem - Mr. V has just been hired to compute the cost of capital of debt, bonds, preference shares and ordinary shares for the L Ltd.

Because L's short term and long term debts do not trade very frequently, Mr. V has decided to use 20% as cost of debt, which is the yield to maturity on a portfolio of bonds with a similar credit rating and maturity as L's outstanding debt. In addition L faces a corporate tax rate of 30%.

L's bonds are frequently traded. A L bond has a $1000 face value and a coupon interest rate of 10% that is paid semi-annually. The bonds are currently selling for $1050 and will mature in 10 years.

L's preference shares pay a 5.5% dividend on a $100 face value. The market price at which the preference shares could be sold is only $60. L's corporation tax rate is 30%. ? L's ordinary shares paid a $0.55 dividend last year. Firm's dividends are growing at a rate of 6% per year and this growth rate is expected to continue into the foreseeable future. The price of these shares is currently $35.

The risk free rate is 7.5% per annum and the average expected rate of return in the market is 9.5% per annum, also L's ordinary shares have a beta of 0.45.

Under the assumption that the firm's present capital structure reflects the appropriate mix of capital sources for the firm, it is determined the market value of the firm's capital structure as follows:

Source of Capital Market Values

Debt $2000000

Bonds $5500000

Preference Shares $2500000

Ordinary Shares $4500000

Retained Earnings $1350000

Required -

(a) What is L's after-tax cost of debt?

(b) What is the cost of L's Bonds?

(c) What is L's cost of preference shares?

(d) What is the cost of L' ordinary shares?

(e) What is L's cost of retained earnings based on the CAPM?

(f) What is L's WACC?