Question

Question 3

Squirrel plc is financed through bonds and equity. The bonds were issued five years ago at a par value of HK$100 (total raised HK$5m) and carry an annual coupon of 10%.The bonds are due to be redeemed in four years, and are currently trading at HK$105.

The following information has also been obtained:

Market value of Shares	HK$4m
Net asset figure	HK$3.5
Return on government securities	8%
Equity risk premium	5%
Beta of Squirrel	0.85
Corporation Tax Rate	30%

Required:

1. calculate the cost of debt capital.                                      
2. Calculate the cost of equity capital.
3. Calculate the weighted average cost of capital. (WACC)                             

4. Discuss whether Squirrel can use the WACC calculated in part c) for evaluating all future capital investment projects   

Answer 1

a. Kd = 10% (1-.30)= 7%

b. Ke = Rf + Beta (Market Premium)

=.08+.85(.08-.05) = 10.55%

c. WACC =

Total Capital =

Bonds+Net Assets(or Equity Funds)= Hk$5m+HK$3.5

=HK$8.5

Wacc= Kd*Wd + Ke * Wd

.07*(5/8.5) + .1055* (3.5/8.5)

=8.46%

d. Yes,Squirrel can use the WACC calculated in part c) for evaluating all future capital investment projects since WACC is the best discount rate as it takes cost of all the capital employed instruments and thus covers all types of investors expectations from there investors.