Question

Rai & Sons firm is considering a new project which would be similar in terms of risk to its existing projects. The firm needs a discount rate for evaluation purposes i.e. the overall cost for the firm. The firm has enough cash on hand to provide the necessary equity financing for the project.
The firm has 10,00,000 common shares outstanding with current price Rs. 11.25 per share.
Next year’s dividend expected to be Rs.1 per share, firm estimates that dividend will grow at 5% per year.
It has 1,50,000 preference shares outstanding. The current price of preference share is Rs. 9.50 per share and dividend is Rs. 0.95 per share. The preference shares were issued at 5% less than the current market price (to ensure they sell) and involve direct flotation costs of Rs. 0.25 per share.
It has a total of Rs. 1,00,00,000 (par value) in debt outstanding. The debt is in the form of bonds with 10 years left to maturity. They pay annual coupons at a coupon rate of 11.3%. Currently, the bonds sell at 106% of par value. Flotation costs for new bonds would equal 6% of par value.
The firm’s tax rate is 40%. The standard deviation on the market portfolio is 10% whereas on the company’s portfolio is 20%. The correlation between the two is 0.5. The government securities carry a return on equity is 15%.
What is the appropriate discount rate (WACC) for the new project using
i. Dividend model
ii. CAPM method ​

Answer 1

Answer:

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