Natural Food (NF) Limited is considering setting up a new farm. It is expected that the farm will generate annual after-tax net cash flows of $8,400,000 in perpetuity with an initial outlay of $30,000,000. Currently, the corporate tax rate is 16% and NF is financed as with the following:
• Retained earnings of $15,000,000
• 1,000,000 ordinary shares with par value of $1, currently trading at $15 each. Dividend for last year was $0.8 with an annual dividend growth rate of 2%
• 50,000 shares of 6% preferred stock (with a $100 par value), now selling for $250 per share
• 40,000 8.5% 10-year coupon bonds with par value of $2,000 and currently trading at 102% of par. Coupons are payable semi-annually
• Long-term bank loan of $45,000,000 at 4%.
Required:
a Weighted average cost of capital calculation is based on certain assumptions. Please comment on any two assumptions in detail. (6 marks)
b Evaluate the weighted average cost of capital of NF. (Hint: Try to show all calculation steps clearly.) (26 marks)
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