Question

Question 3 TIP TOP Berhad has RM50 million in total assets. The firm is considering increasing its non-current assets at the end of the year by RM15 million. The company plans to finance 40% of the expansion with debt and the remaining 60% with equity capital. Bond financing will be at a 10% rate and will be sold at par value. The common stock is currently selling at RM50 per share. The flotation cost for issuing common stock will be RM4 per share. The expected dividend for the coming year is RM3 per share. The dividends are expected to grow at 6% for an indefinite period. The corporate tax rate is 25%. Internal funding available is RM5 million. Required: 3. Calculate the following: i. The after-tax cost of bonds ii. The cost of internal common equity iii. The cost of new common stock b. Calculate the number of new common stock that must be sold, assuming the existing capital structure is to be maintained, subject to full utilization of retained earnings. Calculate the weighted average cost of capital for an investment level of RM15 million.

Answer 1

Bond rate Tax rate After tax cost of debt After tax cost of debt 10% 25% 10%*(1-25%) 7.50% Cost of internal equity As per DDM model Cost of internal equity Cost of internal equity 3/50 + 6% 12.00% Cost of new common stock Cost of new common stock 3/(50-4) + 6% 12.52% Total funding required Debt (40%) Equity (60%) Total retained earnings New equity needed Price of stock Flotation cost No. of new stock 15.00 million 6.00 million 9.00 million 5.00 million 4.00 million 86956.52 4*10^6/(50-4) WACC Debt Retained earnings New equity Total Amount Cost 6.00 7.50% 5.00 12.00% 4.00 12.52% 15.00 WACC 10.34%