FIN3701 Assignment 2 Semester 1 2022

FIN3701 ASSIGNMENT 2 2021

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Question 1
1.1 Calculate the cost of retained earnings, new ordinary shares, preference
shares and long-term debt of Blue Valley Ltd and indicate the maximum
investment that the company makes in the new project before it must issue
new ordinary shares (break point of ordinary shares). (12 marks)
D1
 Cost of retained earnings = +g
V0
2.35(1+0.08)
Cost of retained earnings = + 0.06 = 0.10614 = 10.61%
55
2.35(1+0.08)
 Cost of new issues = + 0.06 = 0.1190 = 11.90%
55−12
Dividends 3
 Cost of preference shares = = = 13.95%
Price of the share−floatation costs 23−1.50




 Cost of debt:
FV = 1 000
PMT = 100 (1000 x 0.10)
PV = 1 175 (1 200 – 25)
N=5
Comp I/Y? = 5.86%
After tax cost of debt = Before-tax cost (1-tax rate)
After tax cost of debt = 5.86(1-0.28) = 4.22%


3 800 000
 Break Point of ordinary shares = = R6 909 090.91
0.55

1.2 Calculate the weighted average cost of capital (WACC) below or at the
break point of ordinary shares. (4 marks)
WACC = (Wd x Kd (1-tax rate) + (We x Ke) + (Wp x Kp)
In this case for equity we will use the cost of retained earnings.
Therefore WACC = (0.30 x 4.22) + (0.55 x 10.61) + (0.15 x 13.95) = 9.194%
1.3 Calculate the WACC above the break point of ordinary shares. (4 marks)
In this case we use the cost of new issues for equity since beyond the break point
the company would have to issue new shares.
WACC = (Wd x Kd(1-tax rate) + (We x Ke) + (Wp x Kp)
WACC = (0.30 x 4.22) + (0.55 x 11.90) + (0.15 x 13.95) = 9.9035%
Question 2