Answer to Question #56755 in Management for Mueni

Question

The following is the capital structure of XYZ Ltd as at 31/12/2002.


Ordinary share capital Sh.10 par value
Retained earnings
10% preference share capital Sh.20 par value
12% debenture Sh.100 par value Shs.M
400
200
100
200
900

Additional information
1. Corporate tax rate is 30%
2. Preference shares were issued 10 years ago and are still selling at par value MPS = Par value
3. The debenture has a 10 year maturity period. It is currently selling at Sh.90 in the market.
4. Currently the firm has been paying dividend per share of Sh.5. The DPS is expected to grow at 5% p.a. in future. The current MPS is Sh.40.

Required
a) Determine the WACC of the firm.
b) Explain why market values and not book values are used to determine the weights.
c) What are the weaknesses associated with WACC when used as the discounting rate, in project appraisal.