Question - Mega Resources Limited's (MRL) is considering a major gold exploration project in South Africa. Costs of financing have been declining recently causing the finance department to consider sourcing capital through debt and equity issues. The company's bonds will mature in five years with a total face value of $100 million, paying a half yearly coupon rate of 8% per annum. The yield on the bonds is 14% per annum. The market value for the company's preference share is $4.75 per unit while the ordinary share is currently worth $1.85 per unit. The preference share pays a dividend of $0.4 per share. The beta coefficient for the ordinary share is 1.4. No issue costs will be incurred by the company.
The market risk premium is estimated to be 10% per annum and the risk-free rate is 4% per annum. The company is subject to a 30% corporate tax rate and intends to issue 200,000 preference shares and 5,000,000 ordinary shares. MRL's current balance sheet shows the following information for bonds and shares:
$ (Million)
Preference shares 3 Ordinary shares 15 Bonds 100
a. Outline the necessary steps required to estimate the company's weighted average cost of capital.
b. Calculate the after-tax cost of each of the company's current financing sources.
c. Using the information provided, calculate the market values for the financing sources for MRL.
d. Using the information from b.) and c.) calculate MRLs after-tax weighted average cost of capital.
e. The company's finance department has confirmed that the proposed project will generate an IRR of 15% per year. Discuss whether or not the project should be undertaken.