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MB0045 : Given the following information, calculate the weighted average cost of capital.

Posted on: October 18, 2011

MB0045 :  Given the following information, calculate the weighted average cost of capital.

Capital structure in millions

Equity capital ( Rs.10 par value)                             2

14% preference share capital Rs.100 each     1.5

Retained earnings                                          2

12% Debentures Rs.100 each                         4

8% term loan                                                  0.5

Total                                                               10

 

The market price per equity share is Rs. 45. The company is expected to declare a dividend per share of Rs.5 and dividends are expected to grow at 15% pa. The preference shares are redeemable at Rs. 115 after 5 years and are currently traded at Rs. 90 in the market. Debentures will be redeemed after 5 years at Rs.110. The corporate tax rate is 30%. Calculate the Weighted average cost of capital.

Solution:

Step I is to determine the cost of each component.

Ke        =          (D1/P0) + g

=          (5/45) + 0.15

=          0.2611 or 26.11%

Kp        =          [D + {(F-P/n}]  / [{F+P/2]

=          [14+ (215-90)/5]  /  (215-90)/2

=          14+25/62.5   =   0.624 or 62.4%

Kr        =          Ke which is 26.11%

Kd        =          [1(1-T) + (F-P) /n}] / {F+P)/2]

=          [12(1-0.3) + (210-90)/5] / (210-90)/2

=          8.4+24/60    = 0.54 or 54%

Kt        =          1(1-T)

=          0.8(1-0.3)   = 0.56 or 56%

Step II    is to calculate the weight of each source.

We       =          2/10     = 0.2

Wp       =          15/10   = 0.15

Wr        =          2/10     = 0.2

Wd       =          4/10     = 0.4

Wt        =          0.510   = 0.05

Step III

WACC            = Weke + Wpkp + Wrk r+ WdKd + WtKt

= (0.2*0.2611) + (0.15*0.624) + (0.2*0.2611) + (0.4*0.54) + (0.05*0.56)

= 0.052 + 0.0936 + 0.052 + 0.216 + 0.028

= 0.4416 or 44.16%

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