Financial Management (Stock Case Study)

Maman Food Industries has been revolutionizing its plastic container and trying to do its part to save the environment. As the chief financial officer (CFO) of a young company with lots of investment opportunities, Maman’s CFO closely monitors the firm cost of capital. The CFO main duty is to consistently monitor and evaluate each of the individual cost of capital: long term debt (25%), preferred stock (25%), and common stock (50%). At the present time, Maman can raise debt by selling, 15 year bonds with a RM 1000 par value and a 10% annual coupon interest rate. Maman’s corporate tax rate is 28% and its bonds generally require an average discount of RM 40 per bond and floatation costs of RM28 per bond when being sold. Maman’s outstanding preferred stock pays an 8% dividend and has RM102 per share par value. The cost of issuing and selling additional preferred stock is expected to be RM12 per share.

Currently Maman’s retained all the profits and practice “zero dividend” policy for the first five years of its inception. To track the cost of common stock the CFO uses CAPM. The CFO and the firm’s investment advisors believe that the appropriate risk free rate is 5% and that the market’s expected return equals 15%. Maman’s CFO estimates the firm’s beta to be 1.8.

Although Maman’s current target capital structure includes 25% preferred stock, the company believes that retiring the outstanding preferred stock will reduce its weighted average cost of capital (WACC), thus shifting their target capital structure to 50% long term debt and 50% common stock. If Maman shifts its capital mix from preferred stock to debt, its financial advisor expects its beta to increase to 2.0.

Required:

a) Calculate Maman’s current after tax cost of long term debt.

Current cash price = Face value – discount value – floatation cost

YTM=Coupon Paid+Face Value+Current Cash PriceYearFace Value+Current Cash Price2

YTM=100+1000-932151000+9322 =100+4.533966 → YTM=0.1082 or 10.82%...