Question

r 2. A company wishes to fund a major project. it will raise 20 million as follows 4 million is bank loan, 6 million in retained earnings, 3 mitlion in common bonds. The bank loan is 12% per year compounded monthly. The pee pe stock is 16.00, 35 cents per share is the earnings per share. year compounded quarterly. What is the weighted average cost of income tax rate of 30%. and 7 million in The bonds yield 4% per capital assuming an Tex rate-30% 733

Answer 1

Weighted average cost of capital is the average cost of Debt and Equity capital of the company.

Formula for weighted average cost of capital = (Weight of equity * Total cost equity) + ( Weight of debt * Total cost of debt)

Retained earning is part of the equity hence total cost of equity is equal to total cost of retained earning.

In the given question:

Total fund raised = 20 million

Bank loan = 4 million

Retained earnings = 6 million

Common stock ( Equity) = 3 million

Bond = 7 million

Bank loan = 12% p.a. ( Compounded monthly )

Share price = 16 and EPS is 35%

Bond yield = 4% p.a. ( Compounded quarterly )

Cost of equity = (Earnings per share / Share price ) = (16 * 35%) / 16 = 35%

Cost of debt is always consider after tax.

Cost of Bank loan ( consider with the annual percentage) = 12%

Effective rate of bank loan = ( 1 + 0.12/12)¹² -1) = 12.68%  

Cost of Bond = 4%

Effective rate of Bond = ( 1 +0.04/4)⁴ - 1 ) = 4.06%

Weighted average cost of capital =

= (Weight of equity * Cost of equity) + ( Weight of Bond * Cost of bond ) + ( Weight of Loan * Cost of bank loan) + ( Weight of retained earning * Cost of retained earning )

= ( 3/20 * 35%) + ( 7/20 * 4.06%) + ( 4/20 * 12.68%) + ( 6/20 * 35%)

= 19.707%