Weighted Average Cost of Capital (WACC)

The company has been investigating a number of projects but has been unable to accurately calculate an appropriate benchmark rate for measuring these projects. You have been supplied with the following information and asked to calculate the weighted average cost of capital (WACC) for the company.

Geotech Consulting

Statement of Financial Position (extract from 30 June 2010 accounts)

Common Stock par value $2.00                                                                4,000,000

14% Preference Shares par value $3.00                                                            3,000,000

12% Bonds semi-annual (face value $100)                                           2,000,000

Term Loan                                                                                                        350,000

Mortgage                                                                                                          700,000

Additional Information:

• The ordinary shares are currently trading at $2.86 while the Preference shares are trading at $3.15.
• Return on government bonds is 4%, the market risk premium 6% and the growth rate in dividends has been consistently 3% over the past five years. A consultant has estimated the company to have a beta of 1.3.
• Corporate tax rate is 35%
• The bonds originally had a 6 year term to maturity and were issued exactly two years ago.
• The before tax return on similar risk bonds is 9%
• Interest on the term loan is 10% and the Mortgage 9%.

Required;

Calculate the weighted average cost of capital for CTRL using the market valuation approach (show your workings).        

Answer:                                            

Need to know an answer and how do you get numbers

Weighted Average Cost of Capital (WACC)   

 The internal rate of return for the project is 13%. While this rate is higher than the market rate, the management would like to compare it to the company’s current cost of capital. You have been provided with the following information and asked to calculate the weight average cost of capital.

The company issued 2,000 six year semi-annual bonds two years ago with a face value of $1,000 and coupon rate of 8%. The bonds are currently trading at $1150. The company also have a 9% term loan with an outstanding principal of $750,000. The only other component of debt is a $1.2 million 7.5% mortgage.

The company have three components of equity including;

·         Retained earnings of                                              $800,000

·         Ordinary shares par value $3.00                           $6 million

·         14% preference shares par value $5.00              $2 million

Additional Information:

• The ordinary shares are currently trading at $4.25 while the Preference shares are trading at $5.50.
• Return on government bonds is 4%, the market risk premium 7% and the growth rate in dividends has been consistently 3% over the past six years. A consultant has estimated the company to have a beta of 1.4.
• Dividends paid per ordinary share last year was $0.75 
• Corporate tax rate is 35%
• The bonds are currently trading for $1150 per bond
• Interest on the term loan is 9% and the Mortgage 7.5%.

Required;

1. Calculate the weighted average cost of capital for Brown Limited using the market valuation approach. (In calculating the cost of ordinary shares you should use the average based on the dividend growth and capital asset pricing model (CAPM) – show your workings).                                                             

Based on your calculation, recommend to the company what they should do in relation to the investment project (include the rationale for your recommendation)