Question

QUESTION 1 The following information is related to JT Company PLC (JT) as at 31st December 2018: Issued share capital of JT is $500 million and it comprises with 1,000,000 ordinary shares. JT is a quoted company and its current share price is $250. The dividend paid for the current year was $40 per share and growth rate of annual dividend payment is 5%. The retained earnings of JT were $100 million. JT has issued irredeemable preference shares for a value of $150 million. This consists of 500,000 preference shares and annual dividend per share is $25. The last traded price of a preference share was $250; and Irredeemable, non-quoted long-term borrowings of JT were $150 million with annual interest rate of 17%. The company pays income tax at the rate of 28% per annum on its profits. Compute the following: a) Cost of ordinary share capital; b) Cost of preference share capital; c) After-tax Cost of debt; d) Weighted average cost of capital (WACC)at market values; and e) Discuss why WACC may not be the best to use as a discounting factor in investment appraisals.

Answer 1

DE Cost of ordinary share capital = D1 / PO + G = ($40 * (1 + 5%)) / $250 + 5% = $42 / $250 + 5% = 0.168 +0.05 = 21.8% b) Cost of preference share capital = Annual dividend / Share price = $25 / $250 = 10% After tax cost of debt = Before tax cost of debt * (1 - tax rate) = 17% *(1 -0.28) = 12.24% d) Securities Ordinary share capital preference share capital Debt Total Market value Weight 250000000 0.47619 125000000 0.238095 150000000 0.285714 525000000 1 Cost of capital Weighted cost of capital 21.80% 10.38% 10% 2.38% 12.24% 3.50% WACC 16.26% 23 24

EXCEL FORMULA:

C 09: Securities Ordinary share capital preference share capital Debt Total Market value =1000000*250 =500000*250 150000000 =C20+C21+C22 Weight =C20/C23 =C21/C23 =C22/C23 =D20+D21+D22 Cost of capital 0.218 0.1 0.1224 WACC Weighted cost of capital =D20*E20 =D21*E21 =D22*E22 =SUM(F20:F22)