Question

In Namibia the market premium is estimated to be 5% and the yield on government bonds is currently at 8%. Pick Ltd has an equity beta of 0.95. Pick has issued bonds with a par value of N$100 which are currently priced at N$96.00. The annual coupon rate is 9%. The maturity date is in five years’ time and the corporate tax is 30%. Interest is payable semi-annually in arrears. The company has just paid the coupon interest for the current six month period.
Required:
a) Calculate Pick Ltd.’s cost of equity based on CAPM. (2 marks) b) Calculate the after tax cost of debts. (6 marks) c) What is the weighted-average cost of capital (WACC) if the target debt-equity ratio is 25%? (6 marks)

Financial management

Answer 1

Answer: Equity's weight = 1/(1 + Debt-to-equity ratio) Debt's weight = Debt-to-equity rartio / (1 + Debt-to-equity ratio) Therefore, Source Equity Debt Weight 0.80 0.20 [1 / (1+25%) = 1/1.25 = 0.80] [25%/ (1+25%) = 0.25/1.25 = 0.20] Therefore, Capital Weighted Source Cost weight Cost Equity 0.80 12.7500% 10.20% Debt 0.20 7.0259% 1.41% Weighted Avg. Cost of Capital (WACC) 11.61% (0.8 x 12.7500%] (0.2 x 7.0259%] [10.20% + 1.41%]

Workings: Using Capital Asset Pricing Model (CAPM), Cost of capital = Risk-free Rate + (Beta x Market Risk Premium) Cost of capital = 8% + (0.95 x 5%) Cost of capital = 8% +4.75% Cost of capital = 12.7500% After-tax cost of debt = Before-tax cost of debt x (1-Tax rate)

# of years to maturity, NPER 10 [5 years x 2] Annual coupon payment PMT N$4.5 [N$100 x 9% / 2] Bond's issue price today, PV N$96 (Given[ Bond's maturity value at the end, FV N$100 [Face value of the bonds due at maturity] Annual coupon payment type, TYPE 0 = 0 if paid at the end of each period; 1 if paid at the beginning of each period Before-tax semiannual cost of debt 5.0185% [Ref: EXCEL SCREENSHOT] Number of semiannuals in a year Before-tax annual cost of debt 10.037% [5.0185% x 21 Tax Rate 30% After-tax annual cost of debt 7.0259% (10.037% x (1-30%) = 10.037% x 70% = 7.0259%] B 2 C D E F G H I 1 # of years to maturity, NPER =5*2 [5 years x 2] 2 Annual coupon payment PMT = 100*9%/2 [N$100 x 9% / 2] 3 Bond's issue price today, PV N$96 [Given[ 4 Bond's maturity value at the end, FV N$100 [Face value of the bonds due at maturity] 5 Annual coupon payment type, TYPE 0 = 0 if paid at the end of each period; 1 if paid at the beginning of each period 6 Before-tax semiannual cost of debt =RATE(B1,-B2,B3,-B4,B5) [Ref: EXCEL SCREENSHOT] 7 Number of semiannuals in a year 8 Before-tax annual cost of debt =B6*B7 (5.0185% x 2] 9 Tax Rate 30% 10 After-tax annual cost of debt =B8*(1-B9) (10.037% x (1-30%) = 10.037% x 70% = 7.0259%] A J 11