Question

The directors of Westwood Limited have appointed you as their financial consultant. They are considering new investment projects and need you to calculate the cost of capital for the company. The present capital structure is as follows:-

3 450 000 ordinary shares with a par value of 75 cents per share. These shares are currently trading at 14.50 per share and the latest dividend paid is 30 cents. An average dividend growth of 13% is maintained.

500 000 14% R3.00 preference shares, with a market value of R5.00 per share.

R5 000 000 non-distributable reserves 

R5 200 000 8% debentures due in 6 years' time and the current yield-to-maturity is 6%, and

R750 000 13% bank loan.

 

Additional information:

The company has a beta of 1.7, a risk-free rate of 5% and enjoys a premium of 8%.

The company's tax rate is 30%. 

 

Required:

4.1 Calculate the weighted average cost of capital, using the Gordon Growth Model to calculate the cost of equity (20)

4.2 Calculate the adjusted weighted average cost of capital, using the Capital Asset Pricing Model as the cost of equity (5)

Answer 1

After Tax Cost of 8% debenture After Tax Cost of 13% bank loan Cost of preferred stock Cost of equity (using the Gordon Growth Model) Market value of 8% debenture Market value of 13% bank loan - Market value of preferred stock • Market value of equity • Total Capital Weight of 8% debenture Weight of 13% bank loan 2 Weight of preferred stock 3 Weight of equity 4 WACC (Cost of equity (using the Gordon Growth Model)] B С 5.60% After Tax Cost of 8% debenture 9.10% After Tax Cost of 13% bank loan 14.00% cost of preferred stock 20.53% Cost of equity (using the Capital Asset Pricing Model) $ 5,200,000.00 Market value of 8% debenture $750,000.00 Market value of 13% bank loan $ 2,500,000.00 Market value of preferred stock $ 2,587,500.00 Market value of equity $ 11,037,500.00 Total Capital 47.11% Weight of 8% debenture 6.80% Weight of 13% bank loan 22.65% Weight of preferred stock 23.44% Weight of equity 11.24% WACC (Cost of equity (using the Capital Asset Pricing Model)] D 5.6096 9.10% 14.00% 18.6096 $ 5,200,000.00 $ 750,000.00 $ 2,500,000.00 $ 2,587,500.00 $ 11,037,500.00 47.11% 6.80% 22.65% 23.4496 10.79%

B 1 After Tax Cost of 8% debenture =8%1-30%) After Tax Cost of 8% debenture |=896 1-3095) 2 After Tax Cost of 13% bank loan - 139°1-30%) After Tax Cost of 13% bank loan -139611-30%) Cost of preferred stock 10.14 Cost of preferred stock 10.14 Cost of equity (using the Gordon Growth Model) +0.3*1+13%)/4.5):139 Cost of equity (using the Capital Asset Pricing Model) 1-5%+1.7890 Market value of 8% debenture 5200000 Market value of 8% debenture 5200000 Market value of 13% bank loan 750000 Market value of 13% bank loan 750000 Market value of preferred stock Market value of preferred stock 5000005 8 Market value of equity 3450000*0.75 Market value of equity =3450000*0.75 9 Total Capital SUMBS:08) Total Capital =SUM D5:08) 10 Weight of 8% debenture =+B5/$B$9 Weight of 8% debenture =+05/$B$9 11 Weight of 13% bank loan =+B6/$B$9 Weight of 13% bank loan =+06/$B$9 2 Weight of preferred stock ==B7/$B$9 Weight of preferred stock +07/$859 13 Weight of equity --B8/SB$9 Weight of equity --D8/$B$9 4 WACC (Cost of equity (using the Gordon Growth Model)]=+(B1*810)+(B2*811)+(83*812)+(B4*B13) WACC (Cost of equity (using the Capital Asset Pricing Model)] =+01'010)+(D2*D11)+(D34D12)+(D4*D13) -5000005

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