EXERCICES on Cost of Capital:

1. PM Company has the following capital structure stated in book value terms:

Source of Capital RM
Bonds (RM1,000 par, 7% coupon) 4,000,000
Preferred stock (RM20 par) 500,000
Common stock (200,000 shares 200,000
outstanding at RM1 par)

The firm's bonds are currently selling for RM900 per bond, the preferred stock for RM16 per
share, and the common stock for RM19 a share.

i) What is the market value of each source of capital and the current total value of the firm
(total financing needed based on market value)?

Bond $4mill /$1000 = 4,000 bonds; 4,000 bonds x $900 = $3,600,000

Preferred Stock $500,000/$20 = 25,000 shares ; 25,000 shares x $16 = $ 400,000
Common stock 200,000 shares x $19 = $3,800,000
TOTAL = $7,800,000

ii) What is the proportion of debt in this firm’s capital structure?

$3,600,000 / $7,800,000= 46.15%

iii) What is the proportion of preferred stock in this firm’s capital structure?
$400,000 / $7,800,000= 5.13%

iv) What is the proportion of common stock in this firm’s capital structure?
$3,800,000 / $7,800,000= 48.72%
2. Aulia Bhd has the following capital structure:

Debt 5000 bonds that pays 10 percent annual coupon has a before-tax yield
to maturity of 12 percent. The bond currently sell for RM980 with
RM1000 par value.

Common 60,000 shares outstanding currently selling for RM50 per share. The
stock company has paid a RM6.50 dividend per share last year and
experiencing 5 percent growth rate in dividends, which it expects to
continue indefinitely.

Preferred 20,000 shares with RM5.00 dividend that sold for RM45 per
stock share….FC =$5

The corporate tax rate is 24 percent.

i. Calculate the weighted average cost of capital (WACC).

Mkt value (RM) Weight(%) Cost (%) Weight x cost

Bond (980x5000)=4,900,000 55.68 12% (1-0.24)= 9.12 5.08%
C.stock (50 x 60,000) = 3,000,000 34.09 [6.50(1.05)/50]+0.05 = 6.36%
18.65
P.stock (45 x 20,000)= 900,000 10.23 5.00/40=12.50% %1.28
Total 8,800,000 100 WACC= 12.72%

This means for every $1 Aulia Bhd raises from investors, it must pay its
investors almost $0.1272 @ $0.13 in return.

ii. Given Project A’ internal rate of return (IRR) is 11 percent and project B’ IRR
is 14 percent, which project should be selected? Why? Assume that this two
projects have the same risk as the firm’s.

Should accept project B….. Because the return (14%) is higher than calculated WACC (cost of
12.58%)