50.1K

Verified Solution

Link Copied!

2) Your client wishes you to investigate a biotechnology company with the following balance sheet and details (below): Long-term debt $ Bonds: Par $100, coupon rate 7% p.a., 3 years to maturity Equity 10,000,000 Preference shares 8,000,000 Ordinary shares 18,000,000 Total 36,000,000 Notes: The company's bank has advised that the interest rate on any new debt finance provided for the projects would be 6% p.a. if the debt issue is of similar risk and of the same time to maturity and coupon rate. There are currently 1,000,000 preference shares on issue, which pay a dividend of $0.85 per share. The preference shares currently sell for $5.69. The company's existing 5,000,000 ordinary shares currently sell for $2.53 each. You have identified that the company has recently paid a $0.45 dividend. Historically, dividends have increased at an annual rate of 2% p.a. and are expected to continue to do so in the future. The company's tax rate is 30%. Your client wishes to understand, with the use of workings, the following aspects of this company and states that their required rate of return for investment in a company with similar characteristics to this particular company would be 11% p.a. Your task is to advise the client on whether you believe this to be a good or bad investment and the rationale for investing (or not investing). You should proceed as follows: a) Determine the market value proportions of debt, preference shares and ordinary equity comprising the company's capital structure. b) Calculate the after-tax costs of capital for each source of finance. c) Determine the after-tax weighted average cost of capital for the company. d) Indicate, giving reasons based on all applicable information, whether you would recommend this biotechnology company to your client (or not). (18 marks) 5 Page

Answer & Explanation Solved by verified expert

See Answer