fm update revision question past year.docx

fm update revision question past year.docx - Question 3 a i...

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Question 3 a) i. Total financing needed: E+D = V E= 500,000 shares X RM16 = RM 8,000,000 D= RM 1,000,000 V= RM8,000,000 + RM1,000,000 = RM9,000,000 ii. Proportion of debt: RM1,000,000 iii. After-tax cost of debt YTM = [ $80 +(995– 1000)/20] / [(995+1000)/2] = 0.08 Answer = 0.08 (1-0.26) = 0.065 iv. Cost of newly issues common stock R E = Rf + β(expected market return-Rf) = 0.07 + 1.5 ( 0.11 – 0.07 ) = 0.13 v. WACC WACC = WeRe + WdRd(1-tax) = 0.89(0.13) + 0.11(0.065) = 0.12285 b) Interpret answer in (v). Weighted average cost of capital (WACC) is the average rate of return a company expects to compensate all its different investors. Therefore, that means for every one ringgit investors had invested in the company they are required to get a return of 12%, which is also a cost for the company. But for the scenario of the question, that means the capital used to finance the asset will have a cost of 12%
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c) Why cost of debt in company always less than cost of equity in a company. Debt is a contractual obligation between a company and its creditors. The contract outlines the repayment of borrowed money typically with interest or fees to the creditors in payment for the use of that capital. The legal contract between creditor and company always places the
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