VM plc is a listed company financed by both equity and debt. VM has listed redeemable bonds with nominal value £5 million,
paying annual interest of 7%. Each £100 nominal value bond has a current market price of £105. An interest payment has just been
made. The bonds have a remaining maturity of 4 years. VM’s corporation tax rate is 25%.
VM has 8 million ordinary shares in issue with a nominal value of 25 pence. A dividend of 10 pence per share was paid last year.
The market expects dividends to grow at a constant rate of 4% each year. The latest closing price of the ordinary shares was 120
pence.
Required:
a) Using appropriate valuation models, calculate the pre- and post-tax cost of VM’s debt. What is the current yield of the bond?
Why don’t we use this as the cost of debt?
b) Using appropriate valuation models, calculate the cost of VM’s equity.
c) Calculate VM’s weighted average cost of capital (WACC).
d) Write down the CAPM formula. e) If the risk free rate is 3.7% and VM’s beta is 2, what is the (1) Market Return (Rm) and (2) the
Market Risk Premium (MRP)?
paying annual interest of 7%. Each £100 nominal value bond has a current market price of £105. An interest payment has just been
made. The bonds have a remaining maturity of 4 years. VM’s corporation tax rate is 25%.
VM has 8 million ordinary shares in issue with a nominal value of 25 pence. A dividend of 10 pence per share was paid last year.
The market expects dividends to grow at a constant rate of 4% each year. The latest closing price of the ordinary shares was 120
pence.
Required:
a) Using appropriate valuation models, calculate the pre- and post-tax cost of VM’s debt. What is the current yield of the bond?
Why don’t we use this as the cost of debt?
b) Using appropriate valuation models, calculate the cost of VM’s equity.
c) Calculate VM’s weighted average cost of capital (WACC).
d) Write down the CAPM formula. e) If the risk free rate is 3.7% and VM’s beta is 2, what is the (1) Market Return (Rm) and (2) the
Market Risk Premium (MRP)?
