Evaluate weighted average cost of capital, Financial Accounting

Assignment Help:

Q. Evaluate Weighted average cost of capital?

As the investment is an extension of existing activities the risk of the investment will be estimated using the company's current equity beta. The cost of equity perhaps estimated using either CAPM or the dividend growth model. Utilizing CAPM

Ke = Rf + (Rm - Rf) beta, or 3·5% + (11% - 3·5%) 1·15 = 12·13%

Utilize the dividend growth model

Ke = D1/P+ g =36·4(1·04)/ 478+ 0·04 = 0·1192 or 11·92%

Both processes give a cost of equity of approximately 12%

The present pre tax cost of debt is 7·5% although this cost will vary as the proposed loan is at a floating rate. The weighted average cost of capital must be estimated using market values of equity and debt. The present market weighted gearing of Zendeck is

Equity 30 million shares at 478 cents = $143·4 million

Debt $34m + ($56m * 1·078) = $94·37 million

This is 60·3% equity 39·7% debt by market values.

WACC = Ke *E/(E+D) + Kd (1-t) *D(E+D)

Maintaining the current capital structure the approximate weighted average cost of capital is

12% (0·603) + 7·5% (1 - 0·3) (0·397) = 9·32%

(ii)

There is no simple method of adjusting the CAPM cost of equity for issue costs instead cash flows would be adjusted when undertaking the investment appraisal.

Utilizing the dividend growth model the revised equation including issue costs is

Ke =D1/(P - I) + g where I is issue costs

Ke =(36·4 (1·04))/ 478 - 31+ 0·04 = 0·851 + 0·04 = 0·125 or 12·5%

(31 is issue costs = 478 × 0.065

Assuming the new debentures carry the similar risk as the existing ones and that there are three years until the redemption of the existing debentures the current gross redemption yield (cost) of debentures may be estimated from

$107·8m =11/(1+ Kd)+11((1 +Kd)2) )+11((1 +Kd)3) )+100((1 +Kd)3)

By trial and error

At 9%

11 * 2·531 =    27·84

100 * 0·772 = 77·20

------

105·04

At 8%

11 * 2·577  =    28·35

100 * 0·794  =  79·40

 ------

 107·75

The gross deliverance yield of existing debentures is approximately 8%.

Assuming the new debentures have a alike risk to existing debentures they will be issued at par of $100 with a coupon of 8%. They are as well assumed to be issued for the expected maturity of the investment, five years. The efficient cost of the debentures may be estimated by solving

267_Evaluate Weighted average cost of capital.png

At 9%

8 × 3·890         = 31·12

100 × 0·065     = 65·00

------

   96·12

At 8% the value is $100 by definition

Interpolating: 8% +3·5/(3·5 0·38) * 1% = 8·90%

The weighted average cost of capital is

12·5% (0·603) + 8·90 (1 - 0·3) (0·397) = 10%

The issue costs as well as use of a different type of debt increase the WACC by about 0·70%.


Related Discussions:- Evaluate weighted average cost of capital

Hsa advantages , A HEALTH SAVINGS ACCOUNT AT FRONTLINE PR Susan Berry...

A HEALTH SAVINGS ACCOUNT AT FRONTLINE PR Susan Berry just returned from a national conference on compensation and benefits where she attended a session on Health Savings Accou

Answer for Assignment, Transaction Entry Information: May 1 Owener H.Hadi ...

Transaction Entry Information: May 1 Owener H.Hadi invested $40,000 in the business

Case law about investment, As an investor, you are considering buying stock...

As an investor, you are considering buying stock in a relatively new company. Medical Horizons, Inc., has been in existence for 10 years and is now about to go public. The first st

Net investment and single net cash flow, Would you invest in a project that...

Would you invest in a project that has a net investment of $14,600 and a single net cash flow of $24,900 in 5 years, if your required rate of return was 12 percent?

Depriciation , an asset has a useful life of 4 years.If it is depriciated b...

an asset has a useful life of 4 years.If it is depriciated by diminishing balance method.Its book value at the end of 4 years is 24% of its original cost.Hence the rate of depricia

Prepare tally & co.''s journal, Tally & Co. incurred a pretax operating los...

Tally & Co. incurred a pretax operating loss of $100,000 in its first year of operations for both financial reporting and income tax purposes. However, it expects to be profitable

Revocation, Revocation, alteration and revival of a will 1. A will may ...

Revocation, alteration and revival of a will 1. A will may be revoked or altered by the maker of it at any time when he is competent to dispose of his free property by will.  (

Monetary policy, Monetary Policy Unlike fiscal policy, monetary policy...

Monetary Policy Unlike fiscal policy, monetary policy is set by unelected officials. A group of economists is appointed by the executive branch and confirmed by the Senate to

Trustees right to be indemnified-trusts laws and accounts, Trustees right t...

Trustees right to be indemnified Trustees have, however, a right to be indemnified: 1. Out of trust property, for all expenses properly incurred in the execution of the tru

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd