Question Solved1 Answer Since its inception, Supreme Plastics Company has been revolutionizing plastic and trying to do its part to save the environment. Its founder, Mr. Mohan Chaubey, developed a biodegradable plastic that his company is marketing to manufacturing companies throughout the northern India. After operating as a private company for 10 years, Supreme Plastics went public in 2015 and is listed on BSE. As the CFO of a young company with lots of investment opportunities, you closely monitor the company’s cost of capital. You keep tab on each of the individual costs of Supremes’ three main financing sources: long-term debt, preference shares and equity shares. The target capital structure for the company is given by the weights in the following table: Source of Capital Weight Long-term debt Preference Share Capital Equity Share Capital 30% 20% 50% At the present time, Supreme Company can raise debt by selling 20-year debentures with a Rs1,000 par value and a 10.5% annual coupon interest rate. The company’s tax rate is 30%, and its debentures generally require an average discount of Rs45 per debenture. Supremes’ outstanding preference shares pays a 9% dividend and has ₹100 per share par value. Because Supreme is a young company that requires lot of cash to grow it does not currently pay a dividend to equity shareholders. To track the cost of common stock, CAPM is advised. The appropriate risk-free rate is 6% and the market’s expected return equals 14%. Using data from 2015 to 2021, the company’s beta is estimated as 1.3. Although Supremes’ current target capital structure includes 20% preference share capital, the company is considering using debt financing to pay outstanding preference shares, thus shifting their target capital structure to 50% long-term debt and 50% equity. If the company makes this change in its capital structure, its beta is expected to rise to 1.5. Decide, by calculating and comparing the current with the proposed weighted average cost of capital, which capital structure to choose.

MON3CD The Asker · Finance

Since its inception, Supreme Plastics Company has been revolutionizing plastic and trying to do its part to save the environment. Its founder, Mr. Mohan Chaubey, developed a biodegradable plastic that his company is marketing to manufacturing companies throughout the northern India. After operating as a private company for 10 years, Supreme Plastics went public in 2015 and is listed on BSE.

As the CFO of a young company with lots of investment opportunities, you closely monitor the company’s cost of capital. You keep tab on each of the individual costs of Supremes’ three main financing sources: long-term debt, preference shares and equity shares. The target capital structure for the company is given by the weights in the following table:

Source of Capital

Weight

Long-term debt

Preference Share Capital

Equity Share Capital

30%

20%

50%

At the present time, Supreme Company can raise debt by selling 20-year debentures with a Rs1,000 par value and a 10.5% annual coupon interest rate. The company’s tax rate is 30%, and its debentures generally require an average discount of Rs45 per debenture. Supremes’ outstanding preference shares pays a 9% dividend and has ₹100 per share par value. Because Supreme is a young company that requires lot of cash to grow it does not currently pay a dividend to equity shareholders. To track the cost of common stock, CAPM is advised. The appropriate risk-free rate is 6% and the market’s expected return equals 14%. Using data from 2015 to 2021, the company’s beta is estimated as 1.3.

Although Supremes’ current target capital structure includes 20% preference share capital, the company is considering using debt financing to pay outstanding preference shares, thus shifting their target capital structure to 50% long-term debt and 50% equity. If the company makes this change in its capital structure, its beta is expected to rise to 1.5.

Decide, by calculating and comparing the current with the proposed weighted average cost of capital, which capital structure to choose.

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