Question

QUESTION 3 (a) A company finances its operations with 40 percent debt and 60 percent equity. The annual yield on the company’s debt is rd = 10% and the company’s tax rate is T = 30%. The company’s common stock trades at Po = K55 per share, and its current dividend of Do =K5 per share is expected to grow at a constant rate of g = 10% a year. The flotation cost of external equity, if it is issued, is F = 5% of the kwacha amount issued. What is the company’s WACC? (6 marks) (b) XYZ Ltd has equity with a market value of K20 million and debt with a market value of K10 million. Treasury bills that mature in one year yield 8% per year (this is also XYZ’s cost of debt) and the expected return on the market portfolio over the next year is 18%. The beta of XYZ’s equity is .90. The firm is in the 30 percent tax bracket. What is XYZ’s weighted average cost of capital? (6 marks) ` (Total: 12 marks

Answer 1

0 copital structure is 40% debt & 60% equity - cost of cebt (d)= 10%. - aften tan cost of debt - 10.1 (1 - 30./.] a 7 calculation of cost of equity ke current price of shore (Po) a 55 _curest dividend (De) 5. constant growth rate (g) = 104. ke = Do (149) tq Po 2 5 (1+10:14 + 10% ke = 0.20 ( 20%. 56

WACCE weguiti tke the debt * kd - 0.60 20+ 0.40 X 7 -2 Note 14-872) af equity is entennal Do (149) tq Po [1-float cost] 5. (1+107) + 10:41 5581-5) _56_+0. = -) 0.205.3 (012 20.63 52.26 Then ware LACC_2 = R _0.60x20.53 5.0.40.0 7. 19.12.13 6 met value of equity - 20 million Mat value of dest = 10 million RE: 84. = this also cost of delt (ko) Rm = 18% B 20.90 after tane cost of debt k = 81. (1-0.30] 616:4 ke RF & ß [Rm=Rf1 - 8:45 0.90 (18-81 3 124 WACC & Wequity & ke + Webbt x kde --- 12:31: _E X 5.62 =) 413-20:2