Question

There are 6 million ordinary shares. Analysts consider it normal to double your money in four years in this industry. The shares last traded at $11.00 per share.
An overdraft of $15 million attracts an interest rate of 6% pa compounded monthly.
90-day bank bills have just been issued with a Face Value of $20m and yield of 4% pa.
Bonds exist with a total face value of $30m, a market value of $30m, a coupon of 5% pa paid semi-annually and 10 years to maturity.
The company accounts show $4m in retained earnings and $3m in trade credit (accounts payable).
The corporate tax rate is 30%.

Calculate the Weighted Average Cost of Capital on an after-tax basis. Explain and defend your treatment of Retained Earnings and Trade Credit.

Need full answer and not in excel

Answer 1

It is given that it takes 4 years to double the money by investing money in this stock

Hence, Cost of Equity can be said as 25%pa

Overdraft : Interest = 15m$/30 * 6%/12 = 2500$

Cost of Overdraft after tax = 2500$/15m$ * 12/1 (1-.30) = 0.20(.70) = 14%pa

Cost of 90 day Bank Bill = 4%(1-.30) = 2.8%pa

Cost of Bonds = 5%(1-.30) =3.5%pa

Cost of Retained Earnings is assumed to be same as Cost of Equity

Hence, Cost of Retained Earnings = 25%pa

Trade Credit should not be included to calculate WACC since it is part of Operations not Financing.

WACC = (25*66/135) + (14*15/135) + (2.8*20/135) + (3.5*30/135) +(25*4/135)

= 15.7%pa

NOTE : All the Decimals are rounded off to 2 points after decimal