Answer to Question #182235 in Economics for Sarah Noor

Question

The following information is related to Arabian Food manufacturing company as of 31st

December 2020

 The company has 50 million common stock shares worth of 400 million dirhams.

 The company’s stocks are currently trading at 20 dirhams per share.

 The company recently paid 3 dirhams per share and expected to grow at 5% annually.

 The company has issued preference shares for a value of 50 million dirhams consisting

of 5 million preference shares and the annual dividend per share is 10 dirhams per share.

 The last traded price of a preference share was 125 dirhams per share.

 The average cost of debt for the company’s long-term debts worth of 150 million

dirhams is 12% per annum.

 The company’s marginal tax rate is 30%.

Required?

(a) Calculate the costs of each sources of capital.

(b) What is the weighted average cost of capital of the company?

Answer 1

(a) The costs of each sources of capital are:

Cost of equity is:

Re = DPS/MPS + r = 3/20 + 0.05 = 0.2.

Cost of debt is 0.12.

Cost of preference shares is: Rp = D/P = 10/125 = 0.08.

(b) What is the weighted average cost of capital of the company?

$WACC = (E/(E + D)×Re) + ((D/(E + D)×Rd) ×(1 – T)) + P/(E + D)×Rp = 400,000/(400,000+150,000 + 50,000)×0.2+150,000/600,000×0.12×(1-0.3) + 50,000/600,000×0.08=0.161.$