1. avatar says

    Dear Sir,
    I have a different kind of question.can you just please help me to solve the following question.

    Assume that ABC Corporation has the following capital structure. 30% debt, 10% preferred stock, & 60% equity. ABC Corporation wishes to maintain these proportions as it raises new’s before tax cost of debt is 8%, it’s cost of preferred stock is 10%, & it’s cost of equity is 15%. if the company’s marginal tax rate is 40%. what is ABC’s WACC?

    Thanks Sir


    • Profile photo of John Moffat says

      The cost of debt is 8% x (1-0.4) = 4.8%
      The cost of preference shares is 10%
      The cost of equity if 15%

      To get the WACC you multiply each cost by the proportions (30%; 10% and 60%) and add them up.

      I do suggest that you watch the free lectures on WACC.

  2. avatar says

    hi! sir could please explain here the concept of perpetuity..i was trying to attept a question relating cost of capital and i could not find the correct is the qustion:
    Q: Z has 10,000 shares in issue, dividends for the next five years are expected to be
    constant at 10 cents per share and then grow at 5% per year to perpetuity; cost of

    • Profile photo of John Moffat says

      Perpetuity means for ever.

      I assume that you have watched the free lecture on the valuation of securities. In which case you will know that the market value of a share is the present value of the future expected dividends.
      In this question, you can calculate the present value of the first 5 years of dividends by discounting the 10c a share using the annuity factor for 5 years at 15%.

      Once you get to the perpetuity (which is from year 6 to infinity) you use the first formula on the formula sheet. However, this formula gives the present value now assuming that the first dividend is in 1 years time. In this question the perpetuity starts 5 years late (it starts at time 6 instead of time 1) and therefore you have to discount the result from the formula for 5 years at 15% to get the present value.

      Finally, if you add the result of the previous paragraph to the result from the paragraph before, you will have the market value of the share – the present value of all the future dividends.

      (If you have not watched the lecture on the valuation of securities then do, because this question in itself has nothing to do with the WACC, which is what the lecture above is about.)

  3. avatar says

    hello sir,please i need a little clarification on the tax rate for redeemable and irredeemable debt. from my own understanding(i might be wrong) we are still deducting tax of 30%. my question is how do we save on tax with irredeemable debt and not save tax on redeembale but yet we still deduct 30%..i think i am confused and have it all mixed up.
    As usual thanks for the great lectures.

  4. avatar says

    Hello Sir, Just wanna ask one thing while calculating cost of debt, you have assumed the interest to be 7 p.a. shouldn’t it be 10? because in example 8, while calculating the same thing you have ignored tax. I’m abit confused where we should ignore tax and where we should consider it. Waiting for your answer.
    Thanking you in anticipation.
    Rehan :)

    • Profile photo of John Moffat says

      I think you must have skipped through the lecture too quickly (or else you have not downloaded the course notes, which makes the lecture impossible!).

      When we are calculating the return to the investor then tax is not relevant – they investor receives the full interest.

      When we are calculating the cost to the company then tax is relevant – the company gets tax relief on the interest which makes the net cost lower.

      I assume that you have downloaded the Course Notes (otherwise it is pointless watching the lectures :-) ) in which case you will see that the requirements for both examples are (a) calculate the return to investors, and (b) calculate the cost of debt to the company.

      I have done the same thing in both examples.

  5. avatar says

    Yeah John! I remember waac formulae was at 2 places in investment appraisal questions. 1 was just easy formuale, the other time it was added with capm( project-specific cost)…!

    • Profile photo of John Moffat says

      Not quite. There is only one way of calculating the WACC.
      The calculation of the cost of equity can be in two ways – using the dividend growth model or using the capital asset pricing model (depending on the information given) – both are covered in our Course Notes and lectures.

  6. avatar says

    Dear John,

    In example 10 of chapter 17 of OT notes – IRR= 5%+12.59/25.06*5%
    I’m bit confused because we first discounted at10% and then we guessed d.f @ 5% because of negative NPV at 10%, comparing this against example 8 shouldn’t IRR be 10%+12.59/25.06*5%

    I’m not sure why you’ve used 5% instead of 10%. Please explain

    Looking forward to your reply.



  7. avatar says

    Dear Sir John Moffart,

    You just make things so simple that i now have confidence in mastering this subject. I like it when, in your humour, you pick on Peter, Valentino, Andrea and ‘Hello, Hello’ for lagging in their attention (smiling…) Your lectures are just soooo joyful and beneficial to hear and watch.

    You are indeed a gem and a great asset to producing future generations of capable accountants!
    Please continue with your antics and style of lecturing. They are very effective and I just love them…..

  8. avatar says

    5% Preference shares ($1 nominal value) 10

    the ex-dividend market value of the preference
    shares is $6·25 million

    what will be the cost of preference shares ????????
    thank you

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