Question

- 4 of 5    ID: FMTH.CC.CD.02

Gertrude's Great Gloves issue bonds with a face value of $10,000, paying interest at j₂ = 11%, redeemable in exactly 12 years. An investor purchases the bond for $10,132.77. Calculate the cost of debt (j₂) for Gertrude's Great Gloves. You may give your answer as a percentage per annum to the nearest percent or use linear interpolation or a financial calculator to give a more accurate result.

Cost of debt =  % pa

- 5 of 5    ID: FMTH.CC.WACC.07A

The following data applies to Micro Advanced Developers (MAD).

Debt	Equity
market value of debt = $81,479	market value of equity = $40,978
time to maturity of debt = 7 years	risk free rate = 4.6% pa
coupon rate = 5.2% pa paid semi-annually	market risk premium = 7.9% pa
face value = $100,000	DDD beta = 1.11

As a financial manager you have been given the task of calculating the company's weighted average cost of capital (WACC). Ignore the effect of taxes.

a)Firstly, you realise that the cost of debt is needed. Calculate the cost of debt for MAD. You may give your answer as a percentage per annum to the nearest percent or use linear interpolation or a financial calculator to give a more accurate result.

Cost of debt =  % pa

b)Secondly, the cost of equity must also be identified. Calculate the cost of equity for MAD. Give your answer as a percentage per annum to 1 decimal place.

Cost of equity =  % pa

c)Finally, calculate the weighted average cost of capital for MAD. Give your answer as a percentage per annum to 1 decimal place.

Weighted average cost of capital =  % pa

Answer 1

Q.No. 4.5
Solution:-
Face value of Bond	10000
Paying Interest	11%
Redeemable in	12 Years
Market value	10132.77
Determining the intrensic value of bond using desired rate of return as 10%
year	Cash Flow	PVF@10%	Pv of CF
1-12	1100	6.8137	7,495.07
12	10000	0.3186	3,186.00
	Intransic Value		10,681.07
Market value is $10,132.77, which is lower than intransic value @10%
Determining the intrensic value of bond using desired rate of return as 11%
year	Cash Flow	PVF@11%	Pv of CF
1-12	1100	6.4924	7,141.64
12	10000	0.2858	2,858.00
	Intransic Value		9,999.64
Market value is $10,132.77, which is greater than intransic value @11%
Therefor Cost of debt will be between 10% to 11%
By using interpolation for determining cost of debt
10%	Change for 1%	11%
10,681.07	681.43	9,999.64
Difference of market value (10681.07-10132.77)	548.30
Cost of Debt	=10%+548.30/681.43*1
	10.80	%
Q.No. 5.5
Solution:-
Cost of Debt Kd(Working Note 1)	13.84	%
Cost of Equity Ke	=Rf+Beta(ER(m)-Rf)
	=4.6+1.11*7.9
	13.37	%
Calculation of Waighted Average Cost of capital
Capital Structure	Amount	Weight	Cost	WACC
Debt	81479	0.67	13.84	9.21
Equity	40978	0.33	13.37	4.47
Total	122457	1.00		13.68
Waighted Average Cost of capital	13.68	%
Working Note 1
Determining the intrensic value of Debt using desired rate of return as 10%
year	Cash Flow	PVF@10%	Pv of CF
1-12	10400	6.8137	70,862.48
12	100000	0.3186	31,860.00
	Intransic Value		102,722.48
Market value is $81479, which is lower than intransic value @10%
Determining the intrensic value of Debt using desired rate of return as 15%
year	Cash Flow	PVF@15%	Pv of CF
1-12	10400	5.4206	56,374.24
12	100000	0.1869	18,690.00
	Intransic Value		75,064.24
Market value is $81479, which is greater than intransic value @11%
Therefor Cost of debt will be between 10% to 15%
By using interpolation for determining cost of debt
10%	Change for 1%	15%
102,722.48	27,658.24	75,064.24
Difference of market value	21,243.48
Cost of Debt	=10%+21243.48/27658.24*5
	13.84	%