Question

Salma Limited finances its operations 40% debt and 60% equity. The company cost of debt is 10%.

Stocks of the company currently trade at $55 and dividends of $5 per share was paid. The share is price

is expected to grow at a constant rate of 10% a year.

**N.B.**

Flotation cost for equity is 5% of the share price;

Tax rate is 30%.

**Compute the following:**

**a) Cost of ordinary share capital;
**

**b) After-tax cost of debt; and
**

**c) Weighted average cost of capital
(WACC). **

Answer #1

a) Proceeds from capital raise per share = share price*(1-flotation cost)

=55*(1-0.05)=52.25

As per DDM |

Price = recent dividend* (1 + growth rate )/(cost of equity - growth rate) |

52.25 = 5 * (1+0.1) / (Cost of equity - 0.1) |

Cost of equity% = 20.53 |

b)

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

After tax cost of debt = 10*(1-0.3) |

= 7 |

c)

Weight of equity = 1-D/A |

Weight of equity = 1-0.4 |

W(E)=0.6 |

Weight of debt = D/A |

Weight of debt = 0.4 |

W(D)=0.4 |

WACC=after tax cost of debt*W(D)+cost of equity*W(E) |

WACC=7*0.4+20.53*0.6 |

WACC% = 15.12 |

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