FINA28027 Corporate Finance 1B

Clearview Systems Ltd. Jasmine Kaur, the newly appointed vice-president of finance for Clearview Systems Ltd. (“CVL”), was eager to talk to her investment banker about future financing for the firm. One of her first assignments was to determine the firm’s weighted average cost of capital (WACC). Capital Structure In their discussion, Jasmine and her investment banker felt that the current mix in the capital structure was providing CVL with the lowest possible WACC and CVL should continue with it in the future. To help her understand the current mix in the capital structure, the controller for CVL provided Jasmine with the following information for the latest year-end (Dec-31-19): The company issued 14,600 bonds, each with a par value of $1,000. They are currently selling for $1,041.00 each. 254,000 common shares have been authorized (with 206,000 shares issued and outstanding). Common shares are selling for $49.000 per share. 189,000 preferred shares have been authorized (with 144,000 issued and outstanding). The closing price of preferred shares was $54.500 per share. Jasmine was able to use this information to calculate the market values and the weights associated with each of the components of the capital structure: (enter your answer in whole numbers: e.g. 1,000,000 not 1.0 million. Don’t enter the dollar sign.) the total market value of outstanding bonds on Dec-31-19 $ the total market value of all issued preferred shares on Dec-31-19 $ the total market value of all issued common shares on Dec-31-19 $ Description Weight (enter all percentages to two decimal places) Debt % Preferred % Common % Cost of WACC Components Of some concern was the appropriate cost to assign to each of the elements in the capital structure. Jasmine requested that the controller provide data on what the costs were likely to be to issue debt, preferred stock and common stock. The controller provided the following information: Debt The bonds were issued 4 years ago with a 25 year maturity and a coupon rate of 7.00 percent (payable semi-annually) Preferred equity The preferred shares were issued six years ago and pay an annual dividend of $2.200 per share. Common equity Last year, CVL declared and paid a common share dividend of $2.430 per share. This represented a 5.00 percent growth in the common share dividend (a rate that is expected to continue into the future) and a dividend payout ratio of 30.00 percent (also expected to continue into the future). Jasmine was already aware that the company’s current tax rate is 45.00 percent and preliminary year-end results show net earnings (after interest, taxes and preferred share dividends) for the year ending Dec-31-19 is $6.0 million. CVL uses RBC as its lead underwriter. RBC charges CVL 4.00 percent commission on new common stock issues, 6.00 percent on new preferred stock issues, and 6.00 percent on new debt issues. RBC has included all direct and indirect flotation costs in these rates. Calculate the after-tax cost of debt: What is the nominal yield-to-maturity on outstanding bonds? % Since the bonds compound semi-annually, what is the effective yield on the bond? % Calculate the after-tax cost of debt using the effective yield. (Note: If you don’t know how to calculate the effective yield, use the nominal yield you calculated in part 1. Show me you know how to calculate after-tax cost of debt, even if you’re starting with the wrong number.) % Calculate the after-tax cost of preferred shares. % Calculate the after-tax cost common equity in the form of retained earnings (ke). % Calculate the after-tax cost of common equity in the form of new shares (kn). % Weighted Average Cost of Capital What is the weighted-average cost of capital if the company uses new debt, new preferred shares and just retained earnings? % What is the weighted-average cost of capital if the company uses new debt, new preferred shares and new common shares? % Jasmine was interested to know the level of investment she could make in new capital assets without needing to find new common shareholders. How much of that can be funded without issuing new common stock? (Hint, how much will the Total Liabilities and Shareholder’s Equity side of the balance sheet go up by?) (enter your answer in whole numbers: e.g. 1,000,000 not 1.0 million. Don’t enter the dollar sign.) $


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