The Ronald Co Ltd (RCL) is contemplating a $40 million national duplication of its replica division. It has forecast after-tax cash flows for the project of $10 million per year in perpetuity. The average yield to maturity of RCL’s is 8 per cent, and its cost of equity capital is 15 per cent. The tax rate is 30 per cent. Harry Lehman, the company’s chief financial officer, has come up with two financial options: 10-year debt at 8 per cent interest. The issue costs would be 1 per cent of the amount raised. Ordinary shares. The issue costs would be 12 per cent of the amount raised.
Cost of Debt, Cost of Preferred Stock
This article deals with the estimation of the value of capital and its components. we'll find out how to estimate the value of debt, the value of preferred shares , and therefore the cost of common shares . we will also determine the way to compute the load of every cost of the capital component then they're going to estimate the general cost of capital. The cost of capital refers to the return rate that an organization gives to its investors. If an organization doesn’t provide enough return, economic process will decrease the costs of their stock and bonds to revive the balance. A firm’s long-run and short-run financial decisions are linked to every other by the assistance of the firm’s cost of capital.
Cost of Common Stock
Common stock is a type of security/instrument issued to Equity shareholders of the Company. These are commonly known as equity shares in India. It is also called ‘Common equity
- The Ronald Co Ltd (RCL) is contemplating a $40 million national duplication of its replica division. It has
forecast after-tax cash flows for the project of $10 million per year in perpetuity. The average yield to maturity of RCL’s is 8 per cent, and itscost of equity capital is 15 per cent. The tax rate is 30 per cent. Harry Lehman, the company’s chief financial officer, has come up with two financial options:
- 10-year debt at 8 per cent interest. The issue costs would be 1 per cent of the amount raised.
- Ordinary shares. The issue costs would be 12 per cent of the amount raised.
The target debt/equity ratio of RCL is 1. The expansion project will have the same risk as the existing business.
- What is the
NPV of the new project at the target debt/equity ratio? - Lehman has advised the company to go ahead with the new project and to utilise the debt option because debt is cheaper, and the issue cost will be less than shares. Is Mr. Lehman correct? Explain.
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