, QUESTION 1: Cost of Capital and Capital Budgeting
1.1 Calculate the WACC associated with each range of financing/break-point
Step 1: Calculate the Cost of Each Component of Capital
Cost of Debt 1: Debentures (Before and After-tax)
o The company issues a R1 000 par value debenture at a 5% discount, incurring a R20 flotation cost.
o Selling price = R1 000 - 5% = R950.
o Net proceeds (𝑁 ) = R950 - R20 = R930.
o Using a financial calculator to find the pre-tax Yield to Maturity (YTM): 𝑁 = 10; 𝑃𝑉 = −930; 𝑃𝑀𝑇 = 80 (8% of
R1000); 𝐹𝑉 = 1000. Compute 𝐼/𝑌𝑅 (Pre-tax 𝑘 ) = 9.09%.
o After-tax cost of debentures = 9.09% × (1 − 0.30) = 6.36%.
Cost of Debt 2: Bank Loan
o The after-tax cost of the bank loan is explicitly given as 10.00%.
Cost of Equity 1: Retained Earnings (𝑘 )
o Current dividend (𝐷 ) = R10.00.
o Expected dividend (𝐷 ) = 𝑅10.00 × (1 + 0.03) = R10.30.
o Market price of a share (𝑃 ): Flotation is R2.70 (3% of R90 par value), and net proceeds are R87.30, meaning
current market price is R90.00 (R87.30 + R2.70).
1.1 Calculate the WACC associated with each range of financing/break-point
Step 1: Calculate the Cost of Each Component of Capital
Cost of Debt 1: Debentures (Before and After-tax)
o The company issues a R1 000 par value debenture at a 5% discount, incurring a R20 flotation cost.
o Selling price = R1 000 - 5% = R950.
o Net proceeds (𝑁 ) = R950 - R20 = R930.
o Using a financial calculator to find the pre-tax Yield to Maturity (YTM): 𝑁 = 10; 𝑃𝑉 = −930; 𝑃𝑀𝑇 = 80 (8% of
R1000); 𝐹𝑉 = 1000. Compute 𝐼/𝑌𝑅 (Pre-tax 𝑘 ) = 9.09%.
o After-tax cost of debentures = 9.09% × (1 − 0.30) = 6.36%.
Cost of Debt 2: Bank Loan
o The after-tax cost of the bank loan is explicitly given as 10.00%.
Cost of Equity 1: Retained Earnings (𝑘 )
o Current dividend (𝐷 ) = R10.00.
o Expected dividend (𝐷 ) = 𝑅10.00 × (1 + 0.03) = R10.30.
o Market price of a share (𝑃 ): Flotation is R2.70 (3% of R90 par value), and net proceeds are R87.30, meaning
current market price is R90.00 (R87.30 + R2.70).
