Grants Limited (Grants) is a company that has issued corporate bonds with a par
ID: 2812716 • Letter: G
Question
Grants Limited (Grants) is a company that has issued corporate bonds with a par value of K100
and a coupon rate of 11%. The total Statement of Financial Position value of the bonds is
K50m. The company’s bonds are currently trading at a price of K103. Interest is payable
annually in arrears. The maturity date is in four years’ time. The company has a target capita
structure of 25% debt, 15% redeemable preference shares, 10% non-redeemable preference
shares, and 50% in ordinary equity financing. Retained earnings and contributed capital
amount to K100m.
The company has two types of preference shares in issue. There are 0.2m non-redeemable
preference shares which were issued at K100 per share and there are 0.3m redeemable shares
which were also issued at K100 and are redeemable at K100 per share. The maturity date of
the redeemable preference shares is in four years’ time. Preference dividends are payable
annually in arrears for both issues. Non-redeemable preference shares are currently priced at
K107 and the redeemable preference shares are currently priced at K104. The coupon rates are
9% for each issue and coupon payments were recently paid.
The company’s beta is 1.20 and the government treasury bill rate is 8%. The market premium
is expected to be 5.5%. The corporation tax rate is 28%.
Required:
(a) What is Grants’ after tax cost of debt?
(b) What is the cost of the two types of preference shares?
(c) What is the cost of equity?
(d) What is the company’s weighted average cost of capital?
Explanation / Answer
a) What is Grants after tax cost of debt Coupon Rate - 11% Corporation Tax 28% After Tax cost of debt 11%(1-0.28) After Tax cost of Debt 7.92% b) What is the cost of the two types of preference shares Cost of Irredeemable preference capital Kp = Dp/Price Dividend = 9%*100 9 Kp = 9/104 0.086538 Kp = 0.086538 Cost of redeemable preference capital Price of redeemable preference shares = Present value of dividend + Present value of par value 107 We will have to calculate, the cost of preference shares by using the trial and error Assuming the cost is 8%, we get Years Cash flow Discount Factor @ 8% Present Value 1 9 0.925926 8.3333 2 9 0.857339 7.7160 3 9 0.793832 7.1445 4 109 0.73503 80.1183 103.3121 Assuming the cost is 6.936%, we get Years Cash flow Discount Factor @ 6.936% Present Value 1 9 0.935139 8.4162 2 9 0.874485 7.8704 3 9 0.817764 7.3599 4 109 0.764723 83.3548 107.00 c) What is the cost of equity Ke = Rf +Beta*(Market Premium) Ke = 0.08 + 1.2*(0.055) Ke = 0.146 d) What is the company's weighted average cost of capital Based on Target capital structure WACC would be 0.25*(0.0792)+0.15*(0.06936)+0.10*(0.0865)+0.50*(0.146) 0.0198+0.010404+0.00865+0.073 11.19% Based on current capital structure, WACC is Amount in $ Percentage Cost Debt 50 33.22% 7.92% 2.63% Reedemable Pref shares 0.3 0.20% 6.936% 0.01% Non Reedemable 0.2 0.13% 8.65% 0.01% Equity 100 66.45% 14.60% 9.70% 150.5 WACC 12.36%
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