You are a business consultant specializing on the cost of capital and the estimation of discount rates capital projects. You start your day with updating your market inputs you will need in estimating the cost of capital estimates for two of your client’s capital projects you are currently working on. First, you find out that long-term government bonds are currently yielding at 4.5%. Nest, based on perusing some financial analyst reports mainly concerned with the outlook for the Australian stock market in the coming year, you decide that an expected market return of 15% is appropriate. Having established these fundamental estimates, which you will require for both assignments, you begin with reviewing the data for your first client.
a. Agape Industrial Ltd is trying to determine its cost of capital for capital budgeting purposes. The company currently has 7,500 bonds outstanding paying a coupon of 7% p.a. The bonds have a $1,000 nominal value and the coupon payments are semi-annual. The bonds are currently selling at $86 and have 12 years to maturity. The company has 300,000 ordinary shares outstanding, currently selling for $62 per share, and 1,000 9.5% preference shares outstanding with a nominal value of $100, currently selling at $92.5 per share. Agape has a tax rate of 30% and a beta of 1.02. It is expected that the company’s capital structure will remain the same for the foreseeable future.
Calculate Agape’s Weighted Cost of Capital (WACC). Show workings. Limit your answer to one
b. Satori Ltd is your second client. One of Satori’s senior managers, Mark Powell, has proposed to enter into a new line of business. Mark’s project analysis yielded an estimated IRR of 26%. In his report, Mark compared the project’s IRR to Satori’s WACC of 12.5% and concluded that the project should be accepted. Given that Mark has a history of overestimating cash flow projections and underestimating the involved risk, the CEO is skeptical and asked you for your comments on Mark’s proposal. Your background research shows that the average beta coefficient for listed companies operating in the proposed business line is 2.0, confirming the high-risk nature of the project. Like Satori, these companies are all equity financed.
Prepare a memo with advise to Satori’s CEO on the proposal. Limit your memo to a maximum of
one A4 page
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