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FIN622 Corporate Finance Assignment No.2 Fall Semester 2013
FIN622 Corporate Finance Assignment No.2 Fall Semester 2013
Corporate Finance (FIN 622)
Assignment No. 2
Due Date: 22nd January, 2013. Marks = 30
“Weighted Average Cost of Capital”
Learning objectives:
To understand the important components of capital structure
To learn the concept of weighted average cost of capital
To understand concept of Pure Play method
Outcomes:
This assignment will enable the students:
1.
To understand how change in capital structure affects weighted average cost of capital
2.
The use of pure Play Method in calculating systematic risk of a project
Case:
R&T Corporation is one of the leading pharmaceutical companies in Pakistan. R&T has been severing this industry for the last 15 years contributing a considerable share in the industry profits. The industry is at its growing stage, so companies have to upgrade themselves to keep pace with arising challenges and to meet the arising needs of this industry. Thus, the management of R & T has been giving emphasis on the Research and Development area and at present, R & T has been able to maintain its position in the industry successfully. Now, the management is considering diversifying its business and planning to enter into beverage industry. For that purpose, a new division named as “Bev –Dept.” is under consideration. Currently, R&T Corporation has 200,000 common shares outstanding with the face value of Rs. 100 each. The Management has decided to generate financing using three sources and details are as follows:
Market Value
Rs.
Book Value
Rs.
YTM
t
Bond-A
3,800,000
3,750,000
15.0%
10 yrs.
Bond-B
2,800,000
2,250,000
12.5%
12 yrs.
Bond-C
1,500,000
1,050,000
14.0%
10 yrs.
R&T is currently paying divided at Rs. 8 per common share and this is expected to grow at 6% in the foreseeable period. In the beverage industry, average equity beta is 1.2 and debt-equity ratio is 40:60. It has been concluded after market analysis that new intended project has a different risk level than that of existing industry.
You are required to compute:
1.
Equity beta for the new project by using Pure Play Method. (10 marks)
2.
Cost of equity capital for the company after introducing new project if T-bills yield is 10%, market required arte of return is 18%. (Use CAPM). (4 marks)
3.
Cost of debt for new project (Based on book value of bonds). (12 marks)
4.
Weighted average cost of capital for the company after issuing bonds (Based on book value of bonds), if tax rate is 35%. (4 marks)
Note: Show complete formulas, calculation and working as they carry marks
IMPORTANT
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DEADLINE:
Make sure to upload the solution file before the due date on VULMS
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FORMATTING GUIDELINES:
Use the font style “Times New Roman” or “Arial” and font size “12”
It is advised to compose your document in MS-Word format
You may also compose your assignment in Open Office format
Use black and blue font colors only
RULES FOR MARKING
Please note that your assignment will not be graded or graded as Zero (0), if:
It is submitted after the due date
The file you uploaded does not open or is corrupt
It is in any format other than MS-Word or Open Office; e.g. Excel,
PowerPoint, PDF etc.
It is cheated or copied from other students, internet, books, journals etc.
Note related to load shedding: Please be proactive
Dear students!
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