Question

1. (a) Calculate the current WACC (weighted average cost of capital) of the company (Tax rate : 19%)

United plc last raised capital over 10 years ago. It has £4m of 11% fixed interest stock maturing in 2024 (current market value £5m), £2.5m 9% fixed interest stock maturing in 2022 (current market value £3m), £1m 7% irredeemable preference shares (current market value £2.5m), and four million 50p (nominal value) ordinary shares (current share price £1.25).

The current gross yield to redemption of all the fixed interest stock is 1.25 per cent per annum. The total return expected on the ordinary shares over the long-term future is 5 per cent per annum.

Answer 1

total debt MV = 5+3+2.5=10.5m

total equity MV = price*shares = 4*1.25=5m

preference shares MV = 2.5m

preference shares cost of capital = dividend*par value/mv = 7*1/2.5=2.8%

Total Assets value = Value of common Equity + Value of Debt + Value of Preference shares

=5+10.5+2.5

18

Weight of common Equity = Value of common Equity/Total Assets Value

= 5/18

=0.2778

Weight of Debt = Value of Debt/Total Assets Value

= 10.5/18

=0.5833

Weight of Preference shares = Value of Preference shares/Total Assets Value

= 2.5/18

=0.1389

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 1.25*(1-0.19)

= 1.0125

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=1.01*0.5833+5*0.2778+2.8*0.1389

WACC% = 2.37