Answer to Question #280547 in Management for Alice

Question

 XYZ Ltd deals with processing and distribution of Sugar. The following is the capital structure of XYZ Ltd as at 31^st December 2014.

 

Capital structure

sh. “000”

Ordinary share capital Sh.10 par value

400

 

10% preference share capital Sh.20 par value

100

 

12 % Debentures Sh.100 par value

200

 

Retained earnings

 

200

 

 

900

 

 

 

 

 

 

During the year the following additional information were available;

 

i.             Currently the firm has been paying dividend per share of Sh.5. The dividend per share is expected to grow at 5% per annum in future. The current market price per share is Sh.40

 

ii.             Preference shares were issued 10 years ago and are still selling at par value

 

iii.             The debentures have a 10-year maturity period. It is currently selling at Sh.90 in the market

 

iv.             Corporation tax rate is 30%

                        Required:

 

i.            Determine the WACC of the firm

Answer 1

Weighted Average Cost of Capital

Ordinary share capital = 10$*$ 400,000 = 4,000,000

Preference Share Capital = 20$*$ 100000 = 2,000,000

Debentures = 100$*$200,000 = 20,000,000

Retained earnings = 200,000$+$ 900,000 = 1,100,000

Total $=$ 27,100,000

Ordinary Shares

 Ordinary Share Capital K_c=D_i$÷$ P_o$+$Q =1.5$÷$ 50$+$ 0.08 = 11%

Book value = 4,000,000

Preference Capital

Cost of Preference Capital K_p=(Dividend$+$ Redemption value$-$ proceeds$÷$ years of redemption$*$ 2$÷$ Redemption$+$ proceeds)$*$ 100

(12$+$ 100-90$÷$ 10$*$2$÷$ 100$+$ 90)$*$ 100

= 13.68%$\%$ $\%$

Book value = 2,000,000

Debentures

Cost of Debentures before tax K_d=( interest rate$+$ redemption value$-$ proceeds$÷$ years to redeem$*$ 2$÷$ Redemption+proceeds)$*$100

(15$+$ 100$-$ 80$÷$ 5$*$ 2$÷$ 100$+$ 80)$*$ 100=21.11%

After tax = 21.11$*$ 0.5=10.56%

Book value=20,000,000

WACC

=K_c$*$ W_c $+$ K_p$*$ W_p$+$ K_d$+$ W_d

11$*$4$÷$ 27.1$+$ 13.68$*$ 2$÷$ 27.1$+$ 10.56$*$ 20$÷$ 27.1

= 10.87%