Your client wishes you to investigate a biotechnology company with the following balance sheet and details (below): Long-term debt $ Bonds: Par $100, coupon rate 7% p.a., 3 years to maturity 10,000,000 Equity Preference shares 8,000,000 Ordinary shares 18,000,000 Total 36,000,000 Notes: The company’s bank has advised that the interest rate on any new debt finance provided for the projects would be 6% p.a. if the debt issue is of similar risk and of the same time to maturity and coupon rate. There are currently 1,000,000 preference shares on issue, which pay a dividend of $0.85 per share. The preference shares currently sell for $5.69. The company’s existing 5,000,000 ordinary shares currently sell for $2.53 each. You have identified that the company has recently paid a $0.45 dividend. 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 11% 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.
Your client wishes you to investigate a biotechnology company with the following
Long-term debt $ Bonds: Par $100, coupon rate 7% p.a., 3 years to maturity 10,000,000 Equity
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