Question: TBC Bank, based in Georgia, is growing rapidly since 2010, it introduced regional branches in South Caucasus, has been rated as the best corporate bank in region and listed on London international stock market. Nowadays Bank is expanding activities and needs 50,000,000 USD; Bank has reserve in retained earnings in amount of $15,000,000, which will be used for new projects. The CFO argued to issue bonds to finance the rest of $35,000,000. Since the bank is in a good financial shape. There would not be any doubt regarding leverage issues; however, he also keeps in mind that in future TBC may need to issue stocks to maintain the proper capital structure. Target capital structure is 40 percent of debt and 60 percent of equity finance. The bank has the following bonds outstanding: par value $1,000, 10 percent coupon rate and maturity of 15 years. Market price of bonds is $1,100; common stock is traded at $25, paying $1.50 dividend, which is expected to grow at 5 percent; marginal tax rate is 20 percent; bond floatation cost is $15; and the stock floatation cost is $1.
a. Calculate TBC bonds yield to maturity under market conditions.
b. What will be the cost of new debt finance? Take floatation costs into consideration.
c. What is your estimate of the cost of new equity financing raised from the sale of common stock?
d. Compute WACC.
e. Compute WACC if Bank maintains the target capital structure.
f. What you will advise the bank CEO and shareholders?