Question Tag: Rights Issue

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  • 14 Marks

FM – Nov 2024 – L2 – Q1a – Sources of Finance

Compare equity and debt financing for business expansion using rights issue and loan notes.

GoodLife Innovations is planning to expand its operations, which will boost its profit before interest and tax by 20%. The company is evaluating whether to fund the GH¢4,000,000 needed for this expansion through equity or debt financing.

If equity financing is chosen, the company will offer a 1-for-5 rights issue to existing shareholders at a 20% discount to the current ex-dividend share price of GH¢5 per share. The par value of the ordinary shares is GH¢1 per share. Alternatively, if debt financing is selected, GoodLife Innovations will issue 20,000 8% loan notes, each with a par value of GH¢200.

The following information was extracted from the financial statement prior to raising new finance:

GH¢’000 Amount
Profit before interest and tax 3,194
Finance costs (interest) (630)
Taxation (564)
Profit after tax 2,000
Equity & Liability:
Ordinary shares 5,000
Retained earnings 10,976
Long-term liabilities: 7% loan notes 9,000
Total equity & liabilities 24,976

GoodLife Innovations currently has a price/earnings ratio of 12.5 times. Corporate tax is payable at a rate of 22%.

Required:
i) Calculate the theoretical ex-rights price per share. 
ii) Calculate the revised earnings per share after the business expansion:

  • assuming equity finance is adopted.
  • assuming debt finance is adopted. 
    iii) Determine the revised share prices under both financing methods after the business expansion. 
    iv) Determine which financing method should be used for the planned business expansion using computations for interest cover and share price changes.

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  • 20 Marks

FM – May 2017 – L3 – Q2 – Financing Decisions and Capital Markets

Calculate gearing ratio, rights issue impacts, and shareholder implications.

LL Plc. is a large engineering company. Its ordinary shares are quoted on the Stock Exchange.

LL Plc.’s Board is concerned that the company’s gearing level is too high and that this is having a detrimental impact on its market capitalisation. As a result, the Board is considering a restructuring of LL Plc.’s long-term funds, details of which are shown here as at 28 February, 2017:

Funding Source Total Par Value (₦m) Market Value
Ordinary Share Capital (50k) 67.5 ₦2.65/share ex-div
7% Preference Share Capital (₦1) 60.0 ₦1.44/share ex-div
4% Redeemable Debentures (₦100) 45.0 90% ex-int

The debentures are redeemable in 2022. LL Plc.’s earnings for the year to 28 February, 2017 were ₦32.4 million and are expected to remain at this level for the foreseeable future. Retained earnings, as at 28 February, 2017 were ₦73.2 million.

The Board is considering a 1 for 9 rights issue of ordinary shares, and this additional funding would be used to redeem 60% of LL Plc.’s redeemable debentures at par. However, some of LL Plc.’s directors are concerned that this issue of extra ordinary shares will cause the company’s ordinary share price and its earnings per share (EPS) to fall by an excessive amount, to the detriment of LL Plc.’s shareholders. Accordingly, they are arguing that the rights issue should be designed so that the EPS is not diluted by more than 5%.

The Directors wish to assume that the income tax rate will be 21% for the foreseeable future and the tax will be payable in the same year as the cash flows to which it relates.

Required:
a. i. Calculate LL Plc.’s gearing ratio using both book and market values. (5 Marks)

ii. Discuss, with reference to relevant theories, why LL Plc.’s Board might have concerns over the level of gearing and its impact on LL Plc.’s market capitalisation. (6 Marks)

b. Assuming that a 1 for 9 rights issue goes ahead, calculate the theoretical ex-rights price of LL Plc.’s ordinary share and the value of a right. (3 Marks)

c. Discuss the Directors’ view that the rights issue will cause the share price and the EPS to fall by an excessive amount, to the detriment of LL Plc.’s ordinary shareholders. Your discussion should be supported by relevant calculations. (6 Marks)

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  • 20 Marks

FM – May 2021 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluate financing options for Gap Plc, including rights issue and debt issue, using CAPM, market dynamics, and strategic implications.

You should assume that the current date is 31 December 2019.
You work for Eko Corporate Finance (ECF). One of the clients for whom you are responsible is Gap Plc (GP).

Gap Plc is a listed company and is seeking to raise ₦560 million to invest in new projects during 2020. Currently, Gap Plc is financed by equity. However, at a recent board meeting, the finance director stated that, since other companies in Gap Plc’s industry have average gearing ratios (measured by debt/equity by market value) of 30% (with a maximum of 40%) and an average interest cover of 6 times (with a minimum of 5 times), perhaps the company should access the debt markets. The finance director presented to the board two alternative sources of finance to raise the ₦560 million.

Equity Issue:
The ₦560 million would be raised by a 1 for 2 rights issue, priced at a discount on the current market value of GP’s shares.

Debt Issue:
The ₦560 million would be raised by an issue of 7% coupon bonds, redeemable on 31 December 2029. The yield to maturity (YTM) of the bonds would be equal to the YTM of the bonds of Eko Ventures (EV), another listed company in Gap Plc’s market sector. Eko Ventures has a similar risk profile to Gap Plc and has recently issued its bonds. Eko Ventures’ bonds have a coupon of 7%, will be redeemed in four years at par, and their current market price is ₦110 per ₦100 nominal value.

There were concerns expressed by a number of board members regarding the debt issue since it has been the long-standing policy of the company not to borrow. Their concerns were how Gap Plc’s shareholders and the stock market would react. The company’s cost of capital would increase as a result of the borrowing, leading to a fall in the company’s value.

An extract from Gap Plc’s most recent management accounts is shown below:

₦m
Operating profit 200
Taxation at 20% (40)
Profit after tax 160

Additional Information:

  1. Gap Plc has an equity beta of 1.1
  2. The risk-free rate is expected to be 3% p.a.
  3. The market return is expected to be 8% p.a.
  4. Gap Plc’s current share price is ₦5 per share ex-dividend.
  5. Gap Plc has 320 million ordinary shares in issue.

Required:

a. Calculate, using the CAPM, Gap Plc’s cost of capital on 31 December 2019. (1 Mark)

b. Assuming a 1 for 2 rights issue is made on 1 January 2020:
i. Calculate the discount the rights issue represents on Gap Plc’s current share price. (1 Mark)
ii. Calculate the theoretical ex-rights price per share. (1 Mark)
iii. Discuss whether the actual share price is likely to be equal to the theoretical ex-rights price. (4 Marks)

c. Alternatively, assuming debt is issued on 1 January 2020:
i. Calculate the issue price and total nominal value of the bonds that will have to be issued to give a YTM equal to that of Eko Ventures’ bonds in the above calculation. (5 Marks)
ii. Discuss the validity of the use of the YTM of Eko Ventures’ bonds in the above calculations. (3 Marks)

d. Outline the advantages and disadvantages of the two alternative sources for raising the ₦560 million, discuss the concerns of the board regarding the bond issue (using the gearing and interest cover information provided by the finance director), and advise Gap Plc’s board on which source of finance should be used. (5 Marks)

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  • 15 Marks

FM – Nov 2021 – L3 – Q7 – Financing Decisions and Capital Markets

Analyze the effects of a 1-for-5 rights issue for James Obasi plc, calculate theoretical ex-rights price, and assess investor options and impacts.

James Obasi plc, a medium-sized drone manufacturing firm, is considering a 1-for-5 rights issue at a 15% discount to the current market price of N4.00 per share. Expected issue costs are N2 million, payable from the funds raised. The proceeds from the rights issue will be used to redeem some of the company’s existing bonds at par.

Financial Information:

Statement of Financial Position (N’000):

Required:

a. Ignoring issue costs and any use of the funds raised by the rights issue, calculate: i. The theoretical ex-rights price per share. ii. The value of rights per existing share. (4 Marks)

b. Identify the alternative actions available to an owner of 1,500 shares in James Obasi plc concerning the rights issue and determine the effect of each action on the investor’s wealth. (6 Marks)

c. Calculate the current earnings per share and the revised earnings per share if the rights issue funds are used to redeem some of the existing bonds.
(5 Marks)

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  • 20 Marks

FM – Nov 2021 – L3 – Q3 – Financing Decisions and Capital Markets

Analyze financing alternatives for ZY Plc's new investment and assess rights issue and bond issue implications.

ZY Plc is an all-equity financed, publicly listed company in the food processing industry. The ZY family holds 40% of its ordinary shares, with the remainder owned by large financial institutions. ZY Plc currently has 10 million ₦1 ordinary shares in issue.

Recently, the company secured a long-term contract to supply food products to a large restaurant chain, necessitating an investment in new machinery costing ₦24 million. This machinery will be operational starting January 1, 2022, with payment due the same day, and sales commencing shortly afterward.

The company’s policy is to distribute all profits as dividends. If ZY Plc continues as an all-equity financed company, it will pay an annual dividend of ₦9 million indefinitely, starting December 31, 2022.

To finance the ₦24 million investment, ZY Plc is considering two options:

  1. A 2-for-5 rights issue, where the annual dividend would remain at ₦9 million. The cum-rights price per share is expected to be ₦6.60.
  2. Issuing 7.5% irredeemable bonds at par with interest payable annually in arrears. For this option, interest would be paid out of the ₦9 million otherwise allocated to dividends.

Under either financing method, the cost of equity is anticipated to remain at its current rate of 10% annually, with no tax implications.

Required:

a. Calculate the issue and ex-rights share prices of ZY Plc., assuming a 2-for-5 rights issue is used to finance the new project as of January 1, 2022. Ignore taxation. (4 Marks)

b. Calculate the value per ordinary share in ZY Plc on January 1, 2022, if 7.5% irredeemable bonds are issued to finance the new project. Assume that the cost of equity remains at 10% each year. Ignore taxation. (4 Marks)

c. Write a report to the directors of ZY Plc that includes: i. A comparison and contrast of the rights issue and bond issue methods for raising finance, referencing calculations from parts (a) and (b) and any assumptions. (6 Marks)
ii. A discussion on the appropriateness of the following alternative methods of issuing equity finance in the specific context of ZY Plc: – A placing – An offer for sale – A public offer for subscription (6 Marks)

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  • 20 Marks

CR – Nov 2020 – L3 – Q2 – Earnings Per Share (IAS 33)

Calculate EPS under various scenarios for Goodwin plc and explain EPS use in investment decisions, including examples of potential ordinary shares.

Goodwin plc
Statement of profit or loss extract for the year ended December 31, 2019

As at January 1, 2019, the issued share capital of Goodwin plc was as follows:

  • 23,000 6% preference shares of N1 each
  • 20,700 ordinary shares of N1 each

Required: Calculate the basic and diluted earnings per share for the year ended December 31, 2019 under the following circumstances:

a. Where there is no change in the issued share capital. (5 Marks)

b. The company made a bonus issue of one ordinary share for every four shares in issue at September 30, 2019. (3 Marks)

c. The company made a rights issue of shares on October 1, 2019 in the proportion of 1 for every 5 shares held at a price of N1.20. The middle market price for the shares on the last day of quotation cum rights was N1.80 per share. (8 Marks)

d. Briefly discuss how investors use the EPS ratio in investment decisions and give TWO examples of potential ordinary shares under IAS 33. (4 Marks)

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  • 20 Marks

FM – Nov 2018 – L3 – Q4 – Strategic Performance Measurement

Evaluate Yemi John Plc’s financial performance and analyze financing options for expansion in line with shareholder wealth and earnings growth.

Yemi John Plc. (YJ) is planning to raise N30 million in new finance for a major expansion of its existing business and is considering a rights issue, a placing, or an issue of bonds. The corporate objectives of YJ, as stated in its annual report, are to maximize the wealth of its shareholders and to achieve continuous growth in earnings per share. Recent financial information on YJ is as follows:

Year 2017 2016 2015 2014
Turnover (Nm) 28.0 24.0 19.1 16.8
Earnings before interest and tax (EBIT) (Nm) 9.8 8.5 7.5 6.8
Profit after tax (PAT) (Nm) 5.5 4.7 4.1 3.6
Dividends (Nm) 2.2 1.9 1.6 1.6
Ordinary shares (Nm) 5.5 5.5 5.5 5.5
Reserves (Nm) 13.7 10.4 7.6 5.1
8% Bonds, redeemable 2024 (Nm) 20 20 20 20
Share price (N) 8.64 5.74 3.35 2.67

The par value of the shares of YJ is N1.00 per share. The general level of inflation has averaged 4% per year in the period under consideration. The bonds of YJ are currently trading at their par value of N100. The values for the business sector of YJ are as follows:

  • Average return on capital employed: 25%
  • Average return on shareholders’ fund: 20%
  • Average interest coverage: 20 times
  • Average debt/equity ratio (market value basis): 50%
  • Return predicted by the capital asset pricing model: 14%

EBIT/closing total capital employed

Required:

a. Evaluate the financial performance of YJ, analyzing and discussing the extent to which the company has achieved its stated objectives of:
i. maximizing the wealth of its shareholders; and
ii. achieving continuous growth in earnings per share. (13 Marks)

Note: Up to 8 marks are available for financial analysis.

b. Analyze and discuss the relative merits of a rights issue, a placing, and an issue of bonds as ways of raising finance for the expansion. (7 Marks)

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  • 20 Marks

FM – Nov 2023 – L3 – SB – Q4 – Financial Risk Management

Assess whether debt or equity financing is more suitable for a business expansion and discuss related financial concepts.

Xeco is considering a N15 million expansion to increase profit before interest and tax by 20%. Financial details for Xeco are as follows:

Item Amount (N’000)
Profit before interest 13,040
Finance charges (interest) (240)
Profit before tax 12,800
Taxation (3,840)
Profit for the year 8,960

Financing Options:

  1. Debt: Issue N15m in 8% loan notes, with each note at a nominal value of N100.
  2. Equity: 1-for-4 rights issue at a 20% discount to current share price (N6.25/share). Xeco has 12 million shares outstanding.
  3. Corporate tax rate: 30%.

Required:

  • a. Evaluate whether Xeco should finance the expansion with debt or equity. (10 Marks)
  • b. Explain the relationship between systematic and unsystematic risk. (5 Marks)
  • c. Discuss the assumptions made by the Capital Asset Pricing Model (CAPM). (5 Marks)

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  • 20 Marks

FM – Nov 2022 – L3 – Q2 – Financing Decisions and Capital Markets

Evaluating financing options (rights issue vs convertible loans) for Balama Plc's expansion.

Balama Plc. (Balama) is a listed manufacturer of dairy products. In recent years, the company has experienced only a modest level of growth, but following the recent retirement of the chief executive, his replacement is keen to expand Balama’s operations.

The board of directors has recently agreed to support a proposal by the new chief executive that the company purchase new manufacturing equipment to enable it to expand its range of dairy products. The new equipment will cost N50 million, and the company is seeking to raise new finance to fund the expenditure in full. However, the board of directors is undecided as to how the new finance is to be raised. The directors are considering either a 1 for 5 rights issue at a price of N2.50 per share with a theoretical ex-rights price of N2.92 or a convertible loan of N50 million.

The loan will be secured against the company’s freehold land and buildings. The company’s share is presently quoted at a price of N3.00 per share.

Required:

a. Explain the terms ‘rights issue’ and ‘convertible loans’. (3 Marks)

b. Explain how the ‘theoretical ex-rights’ price of N2.92 is calculated and why the actual price might be different. Show your workings. (4 Marks)

c. Prepare a report for the board of directors that fully evaluates the two potential methods of financing the company’s expansion plans. (13 Marks)

(Total 20 Marks)

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  • 20 Marks

FM – Nov 2017 – L3 – Q3 – Financing Decisions and Capital Markets

Calculate theoretical ex-rights price, evaluate shareholder options, discuss EMH implications, and analyze market timing for Peter Plc’s equity financing.

Peter Plc. is a large, listed manufacturing company that is currently considering how best to raise new equity finance. One option is to undertake a public issue of new shares, a course of action recently approved by the shareholders. Alternatively, the company is considering a 1 for 4 rights issue at a 10% discount to the current market price of N5.00 per share.

The company has approached several investment banks regarding the potential new rights issue and public issue. During these discussions, one investment bank stated that the precise timing of a rights issue would be of no consequence. The bank is of the opinion that a public issue of new shares should not be undertaken at the present time. It recommended that if the company wishes to pursue a public issue, it should be deferred for a minimum of six months. The bank explained that, at present, the stock market is significantly undervaluing Peter Plc.’s shares. Consequently, the company would have to issue far more shares to raise the required amount of finance than it would in six months.

The Finance Director of Peter Plc. is uncertain about this and, at a recent board meeting where the matter was discussed, made the following statement:

“According to the Efficient Market Hypothesis, all share prices are correct at all times, with prices moving randomly when new information is publicly announced. The analysts at investment banks are unable to predict future share prices.”

Required:

  1. (a) Calculate the theoretical ex-rights price per share and the value of the rights per existing share, assuming the company chooses this option. (2 Marks)
  2. (b) Discuss the alternative courses of action open to the owner of 500 shares in Peter Plc. as regards the rights issue, in each case, determining the effect on the wealth of the investor. (4 Marks)
  3. (c) Discuss the factors that will influence the actual ex-rights price per share. (4 Marks)
  4. (d) Discuss the meaning and significance of the three forms of the Efficient Market Hypothesis and, with specific reference to these, discuss both the recommendation that the company waits for six months before undertaking a public issue and the Finance Director’s statement. (10 Marks)

(Total 20 Marks)

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  • 25 Marks

FM – MAY 2016 – L2 – Q2 – Cost of capital

Calculate SAFOO Ltd's WACC and discuss factors influencing the choice of debt finance, as well as the theoretical ex-right price and value of rights.

a) SAFOO Ltd has in issue 5 million shares with a market value of GH¢3.81 per share. The equity beta of the company is 1.2. The yield on short-term government debt is 23% per year, and the equity risk premium is 5% per year. The debt finance of SAFOO Ltd consists of bonds with a total book value of GH¢2 million. These bonds pay annual interest before tax of 25%. The par value and market value of each bond is GH¢100. The company pays tax at 25%.

Required:
Calculate SAFOO Ltd’s Weighted Average Cost of Capital (WACC).
(10 marks)

b) Choosing an appropriate source of business finance can be a difficult and time-consuming task due to the variety of funding options available. Financing can come in the form of debt or investment, and finance terms can vary significantly.

Required:
i) Discuss FOUR factors that a company should consider when choosing a source of debt finance.
(6 marks)

ii) Explain THREE factors that may be considered by providers of finance in deciding how much to lend to a company.
(3 marks)

c) A company with 20 million shares in issue announces a 2 for 5 rights issue at a price of GH¢3 per share. The market price of the existing shares before the rights issue is GH¢3.70.

Required:
i) What is the theoretical ex-right price?
(3 marks)

ii) What is the theoretical value of the rights?
(3 marks)

 

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  • 5 Marks

FM – April 2022 – L2 – Q4c – Sources of finance: equity

Explain the concept of pre-emptive rights and rights issues, and discuss the advantages to a company for using a rights issue to raise additional capital.

Existing shareholders have some advantages available to them that potential shareholders interested in buying shares from the company do not have. Some of those advantages are pre-emptive rights and rights issues.

Required:
i) Explain the term Pre-emptive rights. (2 marks)
ii) Explain the concept of a Rights issue and explain ONE (1) advantage to a company for using rights issues to raise additional capital. (3 marks)

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  • 20 Marks

FM – NOV 2021 – L2 – Q1 – Economic and regulatory environment | Sources of finance: equity

Functions of the Securities and Exchange Commission and National Insurance Commission; calculation and analysis of a rights issue by LIGRI Bank Ghana Ltd.

a. The Securities and Exchange Commission and the National Insurance Commission are part of a list of regulators established by an Act of Parliament. They play a very critical role in the regulation of the financial services sector in the country.

Required:
i) Explain THREE (3) main functions played by the Securities and Exchange Commission in Ghana. (6 marks)
ii) Explain TWO (2) functions performed by the National Insurance Commission in Ghana. (4 marks)

b) LIGRI Bank Ghana Ltd generates a profit after tax of 15% on shareholders’ funds. The current capital structure of the bank is as follows:

Item GH¢
Ordinary shares 40,000,000
Reserves 80,000,000
Total 120,000,000

The management, with the board’s approval, wishes to raise GH¢50,000,000 from a rights issue to expand their existing operations in the country. The return on shareholders’ funds will not change. The current ex-dividend market price is GH¢4 per share. The right issue price proposed by the Finance Director is GH¢3.8 per share.

Required:
i) Calculate the total number of shares to be issued by the company. (3 marks)
ii) Determine the theoretical ex-right price per share after the issue. (3 marks)
iii) Calculate the new earnings per share after the rights issue. (3 marks)
iv) Comment on the calculations of the theoretical ex-right price calculated in ii) above. (1 mark)

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  • 25 Marks

FM – MAY 2018 – L2 – Q2 – Cost of capital

This question involves calculating the cost of equity, WACC before and after a bond issue, the ex-rights price, and evaluating the impact of a rights issue on a shareholder's wealth.

a) The Finance Director of Vista Hotel has heard that the market value of the company will increase if the weighted average cost of capital of the company is decreased. The company, which is listed on a stock exchange, has 100 million shares in issue and the current ex-div ordinary share price is GH¢2.50 per share. Vista Hotel also has in issue bonds with a book value of GH¢60 million and their current ex-interest market price is GH¢104 per GH¢100 bond. The current after-tax cost of debt of Vista Hotel is 7% and the tax rate is 30%. The recent dividends per share of the company are as follows:

The Finance Director proposes to decrease the weighted average cost of capital of Vista Hotel and hence increase its market value by issuing GH¢40 million of bonds at their par value of GH¢100 per bond. These bonds would pay annual interest of 8% before tax and would be redeemed at a 5% premium to par after 10 years.

Required:

i) Determine the cost of equity capital of the company.
(4 marks)

ii) Calculate the weighted average cost of capital of Vista Hotel in the following circumstances:

  • Before the new issue of bonds takes place;
    (3 marks)
  • After the new issue of bonds takes place.
    (3 marks)

b) The Moorgate Company has issued 100,000 GH¢1 par equity shares which are at present selling for GH¢3.00 per share. It has also issued 50,000 warrants, each entitling the holder to buy one equity share. The warrants are protected against dilution. The company has plans to issue rights to purchase one new equity share at a price of GH¢2 per share for every four shares.

Required:

i) Calculate the theoretical ex-rights price of Moorgate’s equity shares.
(4 marks)

ii) Calculate the theoretical value of a Moorgate right, before the shares sell ex-rights.
(3 marks)

c) The chairman of the company receives a phone call from an angry shareholder who owns 1,000 shares. The shareholder argues that he will suffer a loss in his personal wealth due to this rights issue because the new shares are being offered at a price lower than the current market value.

The chairman assures him that his wealth will not be reduced because of the rights issue, as long as the shareholder takes appropriate action.

Required:

Prepare a statement showing the effects of the right issue on this particular shareholder’s wealth, assuming:

i) He sells all the rights.
(3 marks)

ii) He exercises one half of the rights and sells the other.
(3 marks)

iii) He does nothing.
(2 marks)

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  • 25 Marks

FM – NOV 2018 – L2 – Q2 – Islamic Finance | Sources of finance: equity

Covers Islamic finance focusing on Riba, rights issue calculations and determining the cost of capital for projects.

a) Islamic financing is an emerging model of financing in the global financial markets.

Required:

i) Explain the term Riba in Islamic Finance.
(2 marks)

ii) Explain the THREE (3) perspectives from which Riba can be viewed as forbidden or unacceptable in Islamic Finance.
(3 marks)

b) The Board of Directors of Continental Bank Ghana Ltd (CBGL) decided through a Board resolution to raise additional capital through rights issue to meet the new capital requirement by Bank of Ghana. CBGL plans to issue 1 new share for every 3 shares held by existing shareholders at 10% discount to its existing market price. CBGL currently has 6 million shares in issue at a book value of 2 cedis per share. CBGL maintains a dividend payout ratio of 50% and earnings per share currently is 1.6 cedis. Dividend growth is 5% per annum and this is expected into the foreseeable future. CBGL’s cost of equity is 15%. The issue cost is 600,000 cedis.

Required:

i) Calculate the market price per share.
(2 marks)

ii) Calculate the capitalization of CBGL.
(2 marks)

iii) Calculate the rights issue price.
(2 marks)

iv) Calculate the theoretical ex-right price.
(2 marks)

v) Calculate the market capitalization after the rights issue.
(2 marks)

c) KAF is a manufacturer of consumer electronics based in Accra, Ghana. KAF finances its investments with a combination of equity and debt. Its equity capital comprises 10 million shares which are currently trading on the stock exchange at GH¢2.55 per share. Its equity beta is 2.1 currently. The return on the risk-free security is 12.5% while the equity risk premium is 10%.

Included in KAF’s debt stock are irredeemable bonds that have a total face value of GH¢10 million while their total market value is GH¢12 million. The annual coupon of the irredeemable bonds is 18% but is paid semiannually.

The directors of the company are considering two new investment opportunities, which are described below:

  • Project 1: This is an expansion project in the consumer electronics manufacturing industry. It involves the setting up of a new factory in the northern part of Ghana. KAF would finance it with existing capital.
  • Project 2: This involves the installation of a new factory to manufacture furniture for export to foreign markets. Although this investment is a completely new line of business, KAF plans to finance it with existing capital. The average equity beta for the furniture manufacturing industry is 1.52 and the average industry capital structure is 60% equity and 40% debt.

It is expected that KAF’s tax rate will remain at 22%.

Required:

i) Compute the cost of capital that should be used as a discount rate for appraising Project 1.
(5 marks)

ii) Compute the cost of capital that should be used as a discount rate for appraising Project 2.
(5 marks)

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