Question

Use the following information to answer questions 15–20

The existing capital structure of Leeds (Ltd) is as follows:

Notes:

•  The ordinary shares are currently trading at R46,45. A dividend of 80 cents per share has just been paid and the directors estimate that the dividends will increase by 8% each year in perpetuity.

•  Preference shares are trading at R2,75 and have a par value of R2,40.

•  The debentures have a par value of R50 and are currently trading at R45. The

  debentures are redeemable at R55 in ten years’ time.

•  The company tax rate is 28%.

  As an alternative to the existing capital structure for Leeds (Ltd), an outside consultant has suggested the following modifications:

Ordinary shares (equity)	R500 000
11% non-redeemable preference shares	R150 000
Debt (10% debentures)	R350 000

Ordinary shares (equity)	35%
Preference shares	5%
Debt	60%

Under this new and more debt-orientated arrangement, the after-tax cost of debt is 10,8%, the cost of preference shares is 11% and the cost of equity is 15,6%.

15. 15 Under the CURRENT capital structure (before the suggested change) of Leeds Ltd, calculate the cost of equity: (3)

    1. a) 10,00%

    2. b) 9,86%

    3. c) 9,00%

    4. d) 9,43%

16. 16 Under the CURRENT capital structure (before the suggested change) of Leeds Ltd, calculate the cost of preference shares: (3)

    1. a) 9,43%

    2. b) 9,60%

    3. c) 10,00%

    4. d) 12,67%

17. 17 Under the CURRENT capital structure (before the suggested change) of Leeds Ltd, calculate the cost of debt. (3) a) 11,68%

    2. b) 9,67%

    3. c) 9,40%

    4. d) 9,43%

18. 18 Using your calculated cost of capital calculated in Question 1.15–1.17, calculate Leeds’s weighted average cost of capital (WACC) using the current capital structure. (3)

    1. a) 9,40%

    2. b) 9,60%

    3. c) 9,67%

    4. d) 9,00%

19. 19 Calculate Leeds’s weighted average cost of capital (WACC) using the ALTERNATIVE capital structure and alternative costs of capital. (3)

    1. a) 12,49%

    2. b) 13,00%

    3. c) 12,50%

    4. d) 20,00%

20. 20 If you owned your own organisation that was funded by your own capital, would the concept of WACC apply to you? (2)

    1. a) There would be no WACC as there would not be any form of a pool of

       external capital that would exist. However, your ‘own’ cost of funding (equity)

       will need a return level that will be set by yourself.

    2. b) Yes, there will be WACC as there would a pool of external capital that would

       exist.

    3. c) WACC is irrelevant to how capital is funded.

    4. d) Not necessarily, it depends on the company in question.

Answer 1

15. 9.86%

16. 9.6%

17. 9.43%

18. 9.67%

19. 12.48%

20. Option a