Excel Microgrid Ltd (EML) has the following capital structure, which it considers to be optimal: debt (15%), preference
Posted: Thu May 05, 2022 7:58 am
Excel Microgrid Ltd (EML) has the following capital structure,
which it considers to be optimal: debt (15%), preference shares
(25%), and ordinary shares (60%). The company's tax rate is 30%,
and investors expect earnings and dividends to grow at a constant
rate of 7% per year into the future. EML paid a dividend of $2.65
per share last year, and its shares currently has a price of $55.
Long term Government bonds yield 5% per year and the market risk
premium is 7% per year. The estimated beta for EML is 1.20. The
company has the following terms that apply to new security
offerings: • Preference shares: New preference shares could be sold
to the public at a price of $80 per share, with a dividend of $6.
Flotation costs of $5 per share would be incurred. • Debt: Debt
could be sold at an interest rate of 8% per year • Ordinary shares:
New common equity will be raised only by retaining earnings
Required:
a. Find the individual costs of the following sources of finance
(5 marks each): • Debt, • Preference share, and • Ordinary
share
b. Calculate the company’s after-tax weighted average cost of
capital. 5 marks.
c. The finance manager has confirmed that the project would
generate an IRR of 15% per year. Based on your calculation in b.),
should this project be undertaken by the company? Discuss your
recommendation and support with relevant calculations. 5 marks.
which it considers to be optimal: debt (15%), preference shares
(25%), and ordinary shares (60%). The company's tax rate is 30%,
and investors expect earnings and dividends to grow at a constant
rate of 7% per year into the future. EML paid a dividend of $2.65
per share last year, and its shares currently has a price of $55.
Long term Government bonds yield 5% per year and the market risk
premium is 7% per year. The estimated beta for EML is 1.20. The
company has the following terms that apply to new security
offerings: • Preference shares: New preference shares could be sold
to the public at a price of $80 per share, with a dividend of $6.
Flotation costs of $5 per share would be incurred. • Debt: Debt
could be sold at an interest rate of 8% per year • Ordinary shares:
New common equity will be raised only by retaining earnings
Required:
a. Find the individual costs of the following sources of finance
(5 marks each): • Debt, • Preference share, and • Ordinary
share
b. Calculate the company’s after-tax weighted average cost of
capital. 5 marks.
c. The finance manager has confirmed that the project would
generate an IRR of 15% per year. Based on your calculation in b.),
should this project be undertaken by the company? Discuss your
recommendation and support with relevant calculations. 5 marks.