Cost of capital
Biddle with Solution
Biddle
Biddle has profit before interest and tax of £11,080,000. The market value of
shares is 92p per share cum div. Debentures have a market value of £103.00
ex-interest. An interim dividend of 6p has just been declared. Corporation tax
is at 25% and all earnings are paid out as dividends. Biddle’s financial
statements show the following capital structure. It is now 1 January 2006 and
debenture interest is paid on the 31 December each year. The debentures
will be redeemed on 31 December 2009 at par. Earnings are expected to
grow by 3% per annum.
£000
Ordinary shares (nominal value = 25p) 12000
Reserves 24000
36000
12% debenture 2009 (Par value £100) 23000
59000
Required:
Calculate the Weighted Average Cost of Capital for the company.
, Biddle
Solution
The first step is to calculate the recent dividend.
We are told that all earnings will be paid out as dividend so we need to
calculate the earnings.
We are given Profit before interest and tax of £11,080,000 so we need to
deduct the interest and tax to get the profit for the year. As there are no
preference dividends then the earnings are equal to the profit for the year.
Interest will be paid on the debentures based on the coupon and the principal
= 12% x £23 million = £2,760,000. Tax will then be deducted at 25% of the
Profit before tax as shown in the table below:
£000s
Profit before interest and tax 11080
Interest as calculated (2760)
Profit before tax 8320
Taxation at 25% (2080)
Profit after tax 6240
The amount to be paid out in dividends will be all of the earnings i.e.
£6,240,000.
This total dividend can now be used with the total market value to calculate
the cost of capital. Alternatively both dividend and market value can be
translated into a per share value by dividing the total dividend and total market
value of the company by the number of shares.
The share capital is £12,000,000 but the nominal value is 25p therefore there
are 4 shares for every £1 of share capital so there are 12 million x 4 shares
i.e. 48 million shares.
Total dividend 6,240,000
Total shares 48,000,000
Dividend per share 6240/48000 = 0.13 = 13p per share
The total dividend for the year will be 13p but only 6p is being paid out now as
an interim dividend. Remember it is the ex-div market value that we need to
calculate the cost of equity. We have been given the cum div market value so
we need to deduct the 6p interim dividend as it will have been “added onto”
the market value of the share.
Cum div market value 92p
Recently declared div 6p
Ex div market value 86p
Biddle with Solution
Biddle
Biddle has profit before interest and tax of £11,080,000. The market value of
shares is 92p per share cum div. Debentures have a market value of £103.00
ex-interest. An interim dividend of 6p has just been declared. Corporation tax
is at 25% and all earnings are paid out as dividends. Biddle’s financial
statements show the following capital structure. It is now 1 January 2006 and
debenture interest is paid on the 31 December each year. The debentures
will be redeemed on 31 December 2009 at par. Earnings are expected to
grow by 3% per annum.
£000
Ordinary shares (nominal value = 25p) 12000
Reserves 24000
36000
12% debenture 2009 (Par value £100) 23000
59000
Required:
Calculate the Weighted Average Cost of Capital for the company.
, Biddle
Solution
The first step is to calculate the recent dividend.
We are told that all earnings will be paid out as dividend so we need to
calculate the earnings.
We are given Profit before interest and tax of £11,080,000 so we need to
deduct the interest and tax to get the profit for the year. As there are no
preference dividends then the earnings are equal to the profit for the year.
Interest will be paid on the debentures based on the coupon and the principal
= 12% x £23 million = £2,760,000. Tax will then be deducted at 25% of the
Profit before tax as shown in the table below:
£000s
Profit before interest and tax 11080
Interest as calculated (2760)
Profit before tax 8320
Taxation at 25% (2080)
Profit after tax 6240
The amount to be paid out in dividends will be all of the earnings i.e.
£6,240,000.
This total dividend can now be used with the total market value to calculate
the cost of capital. Alternatively both dividend and market value can be
translated into a per share value by dividing the total dividend and total market
value of the company by the number of shares.
The share capital is £12,000,000 but the nominal value is 25p therefore there
are 4 shares for every £1 of share capital so there are 12 million x 4 shares
i.e. 48 million shares.
Total dividend 6,240,000
Total shares 48,000,000
Dividend per share 6240/48000 = 0.13 = 13p per share
The total dividend for the year will be 13p but only 6p is being paid out now as
an interim dividend. Remember it is the ex-div market value that we need to
calculate the cost of equity. We have been given the cum div market value so
we need to deduct the 6p interim dividend as it will have been “added onto”
the market value of the share.
Cum div market value 92p
Recently declared div 6p
Ex div market value 86p
