Natural Food 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 Natural Food Limited is financed as follows:
– Retained earnings of $15,000,000
– 1,000,000 ordinary shares with a par value of $1, currently trading at $15 each. The dividend for the 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 a par value of $2,000 and currently trading at 102% of par. Coupons are payable semi-annually.
– A long-term bank loan of $45,000,000 at 4%.
a. When the weighted average cost of capital (WACC) is used by financial managers to evaluate investment decisions, the assumptions underlying the WACC should be taken into consideration. Please discuss these assumptions.
b. Determine the weighted average cost of capital for Natural Food Limited.