Question

(b) How do you calcune SCHUIT 02. Calculating the cost of equity suppose stock in DAMAC Properties, Dubai has a beta of 80. The market risk premium is 6 percent, and the risk-free rate is 6 percent. DAMAC's last dividend was $1.20 per share, and the dividend is expected to grow to at 8 percent indefinitely. The stock currently sells for $45 per share. What is DAMAC's coast of a capital? (5 marks) Q3. Calculating the weighted average capital coast (WACC) In addition to given in the previous problem, suppose DAMAC has a target dept.-equity Its coast of dept. is 9 percent before taxes. If the tax rate is 35 per (5 marks) (WACC) In addition to the information AC has a target dept.- equity ratio of 50 percent. fore taxes. If the tax rate is 35 percent, what is the WACCO 04. Many companies calculate their weighted average cost of capital (w their discount rate is crucial in budgeting in order to generate a fair value equity when budgeting for a new project. What's the Difference Cost of Rate? of capital (WACC) and use it as fair value for the company's ce Cost of Capital vs. Discount (5 marks)

Answer 1

A-2

Beta	0.8
Risk Premium	6%		Rate of Return = Risk Free Rate + Market Risk Premium
Risk free rate	6%		Thus, ROR=6%+6%=		12%
Last Dividend	1.2
Growth Rate	8%
Current Price	45.00
Cost of Equity	?
As per Gordon's Model,
Ke=(d1/p)+g
where,
ke =	Cost of Equity
d1 =	Dividend of next year
p =	Current Price
g =	Growth Rate
ke=((1.2+8%)/45)+8 =		10.88%

A-3

Cost of Debt before tax		9%
Tax Rate		35%
kd (i.e Cost of Debt after tax)	9*(100%-35%)	5.85%
Debt -Equity ratio is 50%
Therefore, Debt : Equity = 1:2
Particulars	Cost	Ratio	Weighted Cost
Debt	5.85%	1	1.95%
Equity	10.88%	2	7.25%
WACC		3	9.20%

A-4

The cost of capital refers to the actual cost of financing business activity through either debt or equity capital.Whereas, The discount rate is the interest rate used to determine the present value of future cash flows.

A Company may have a higher WACC , but cashflows are discounted at lower rate, if interest rate charged by the Federal Reserve Bank to commercial banks is lower. Or Vice-versa is also possible.