MN10311 seminars questions to revise for exams: WACC equity debt

ANDERSON
Anderson plc is financed by both equity and debt. The company has 3 million ordinary
shares in issue with a nominal value of £1. A dividend of 25p per share has just been
declared and the dividend policy is for dividends to grow each year by 5%. The market
value (cum-div) of the share today is £2.60.
The company also has £2,000,000 of redeemable debt. The coupon rate is 8% and the debt
is redeemable in three years at £108. The current market value (ex-interest) is £106.
Corporation tax is 25%.

Required:
Using appropriate models calculate the weighted average cost of capital for the company.


Ke = Do (1+g) + g
P

Ke = 0.25 (1.05) + 0.05 = 0.1617 = 16.2%
2.35


Kd = redeemable debt

Map cashflows and calculate IRR.

I = 8% X £100 = £8. After tax @ 25% = 8 (1 – 0.25) = 6

Discount Present DF 6% PV AT DF
factors @ 8% value 6%
0 106 1 106.00 1 106
1 (6) Annuity (15.46) 2.673 (16.04)
factor 3 years
= 2.577
2 (6)
3 (6)
3 (108) 0.794 (85.75) 0.84 (90.72)
(101.21) (106.76)
4.79 0.76

IRR = 6% + [0.76/(4.79+0.76) x (8% - 6%)] = 6.27%

WACC

Units MV per unit Total MV Cost of capital
3 million ord £2.35 7050 0.1617
2 million debs £106 per £100 2120 0.0627
9170

WACC = 0.1617 x (7050/9170) + 0.0627 x (2120/9170) = 0.1243 + 0.0145 = 0.1388

WACC = 13.9%.