Identify and Evaluate the Sources of Long-Term Finance Available to Essay

Identify and Evaluate the Sources of Long-Term Finance Available to the Company - Essay Example Thirdly, the result from the previous estimation will be analyzed. Finally, this study will give recommendation on how the project should be financed if the board of director decides to carry out the project. TASK 1: Estimate the Weighted Average Cost of Capital for Made-Up PLC The author will now undertake the estimation of the company’s weight average cost of capital (WACC) by estimating the cost of capital from each financial source of the company. The company currently has three long-term sources of finance, which are ordinary shares, preference shares and bond issuance. 1: The Cost of Ordinary Shares, Ko The company has 4,600m of ordinary shares currently sold on the market at ?1.55 per share. Hence, the market value of ordinary shares is: 1.55 * 4,600m = ?7,130m One method which can be used to estimate the cost of ordinary shares is Capital Asset Pricing Model (CAPM). ... Hence, the rate of return on long term (10 years) UK government Bond will be used for this case. According to the data from Bloomberg, the rate was quote as 2.35% (Bloomberg, 2011). In estimating a beta (?) for the company, there are two estimation methodologies, using a ? of an existing firm in the same line of business and averaging ?s of several companies in the same industry. In this analysis, the ? is derived from that of an existing firm with similar capacity to Made-UP Plc’s. This estimation has an advantage over the average ? methodology since firms within the same industry could have very different ?s and the resulted ? could be unpredictable and unsuitable to Made-UP Plc’s. Since Made-UP Plc’s and TESCO are ones of the largest firms in the industry and have very similar lines of business, the TESCO’s beta will be used for this case, which is 0.7546 (Financial times, 2011). In the case of risk premium, the figure is taken from an empirical study b y Fernandez and Campo (2010). They investigated the average market risk premium used by analysts and companies in the UK in 2010. The result indicated that the average market risk premium used by analysts was 5.2 and 5.6 for the companies. The author will use 5.2 for this case. According to the figures above, the cost of ordinary share can be calculated as follows, The cost of ordinary shares = 2.35 + (0.7551 * 5.2) = 6.28% 2: The Cost of Preference Shares, Kp The company has 150m of irredeemable ?1 nominal preference shares with coupon rate of 5%, payable annually. The shares are currently selling at ?0.68 per share. Hence, the market value of preference shares is: 150m * ?0.68 = ?102m The Cost of preference shares can be calculated by