Reference no: EM132918549

ABC Ltd has decided to use the weighted average cost of capital (WACC) to discount the after-tax cash flows associated with project evaluation. You have been given the task of determining the after-tax WACC of the firm.

You are informed that ABC Ltd uses the following securities to fund its operation:

• 30,000 individual bonds with 7%, 10-year $1,000 face value that were issued 2 years ago have 8 years remaining and offer a coupon that is paid half-yearly. The current market interest rate for these bonds is 5% per annum.
• 2,000,000 ordinary shares, which recently paid a dividend of 50 cents. Dividends are expected to grow at 4% per annum perpetually. The current share price is $20.
• Using the historical data, the covariance between the returns of ABC Ltd and the returns of S&P/ASX200 is found to be 0.0025 and the standard deviation of S&P/ASX 200 returns is 0.0458. The risk-free rate is currently 1.65% per annum, and the market risk premium is 6% per annum.
• For the cost of equity calculation, ABC Ltd has decided to use the average of two values obtained from the constant growth model and the CAPM.
• 1,000,000 preference shares, which pay an annual dividend of 50 cents. Each preference share trades at a market price of $8.
• The company tax rate is 30%.

Required:

Problem a) Compute the WACC.

Problem b) Your company is considering an acquisition of Sun Ltd whose WACC is 10%. Your company's purchase of Sun Ltd will cost 100 million, and will generate cash flows that start at $9 million in Year 1 and then grow at 3% per year forever. The cost of environmental clean-up is expected to be $300,000 per year starting from Year 5 in perpetuity. What is the NPV of the acquisition? Should your company go ahead with the acquisition and why?