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** All ammounts in the Balance Sheet below are in $(m)
Balance Sheet for December 2014
Fixed Assets ……………………………………..1511
Current Assets …………………………………..672
Current Liabilities ……………………………….323
Total Assets less current liabilities ………..1860
7% irredeemable debentures ……………….300
9% debentures (reedemable Dec 2020) …650
9% bank loans ……………………………………560
Ordinary Shares (50p) …………………………200
Reserves …………………………………………..150The Management Team was provided with the following:
• Yield on government Treasury bills 7%
• Company equity beta 1.21
• Market risk premium 9.1%
• Current ex-div ordinary share price $2.35
• Current ex-interest 7% debenture market value $0.66
• Current ex-interest 9% debenture market value $105
• Corporate tax rate 30%The investment the company will make is $125 million, resulting in cash flows of $16 million per year before tax. The investment will be financed as follows;
– $8.8m issue of 10% debt capital
– remainder in equityDid anyone manage to get a WACC of 7%? If not how did you reason this out? I can provide the workings I used, but do not wish to bias your answer for now 🙂
Thanks
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I just got 12.45% when I did it and this is how.
Market Values are:
Ordinary shares (200m at 50p = 400m shares) 400m x 2.35 = $940m
7% debentures are at 300x 0.66 = $198m
and 9% debenture shares are at 650 x 1.05 = $682.5m
This totals to $1820.5mCost of equity is E = risk free rate (treasury bill rate) + beta (market risk premium)
E = 7 + 1.21 (9.1)
E = 18%7% debentures are irredeemable so 7/66 = 10.6%
9% debentures are redeemable and there discounted over 6 years (december 2020)
so at 5% discount rate i got +1.58, at 10% i got -21.16
IRR = 5 + (10 – 5)(1.58/22.74)
IRR = 5.35%WACC = 18(940/1820.5) + 10.6(198/1820.5) + 5.35 (682.5/1820.5)
WACC = 12.45%That’s what I got aha
Thanks for the very very fast reply. I’m impressed.
Let me compare your workings to mine and follow your logic, and see were I went wrong.
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I forgot to mention when working out IRR, MV is 105, interest after tax is 6.30 (9 x 0.7) and redemption value is 100
Hello, so I sat down and compared my workings with yours and have the following comments.
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Comment 1: I used a different Cost of Equity formula. If you take a look at https://termsexplained.com/832766/cost-of-equity there are two formulas;
Formula 1: Cost of Equity = Risk Free Rate + Beta Coefficient × Market Risk Premium
Formula 2: Cost of Equity = Risk Free Rate + Beta Coefficient × (Market Rate of Return ? Risk Free Rate)
Whereas you used Formula 1, I used Formula 2 and the Cost of Equity is quite different using the two formulas.
_____________________________________________________________Comment 2: I worked out the IRR (or YTM) formula to determine the rate the bonds would fetch if they were issued today;
YTM = (C + ((F – P) / 2)) / ((F + P) / 2)
Where
C = Interest Payment minus tax i.e. 6.3%
F = Face Value of debenture i.e. 100
P = Current debenture price i.e. 105
n = Years to maturity i.e. 6I got 5.33%
May you please explain your IRR working, and why you used your approach?
Hello, I was also wondering why you did not consider the 9% bank loans as a source of capital? If you take a look at this post – https://opentuition.com/topic/wacc-2/
you could tell that bank loans, as a source of capital should be included in the WACC.
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Can I just say I’m doing ACCA f9 but this comes up on our exam too but we never include bank loans in our q’s?
In regards to cost of equity, both of the formulas you have are the same. Market risk premium is just short for market risk return – risk free rate, you’re left with te premium aren’t you.
And our IRRs are practically the same, just rounding probably, won’t have an effect on wacc- Topics: 0
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But reading that article, I assume you factor in the bank loan too. (It’s something that isn’t in my syllabus so…) :p
I will have to do more research on bank loans, but intermittently from other sources it seems that bank loans should be included in WACC. But I still need to establish this is a fact.
On Market Risk Premium I agree 🙂
Is ACCA f9 particularly based on Financial Statements?
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Pretty much, working capital management, cost of capital, business valuations and investment appraisals cover the majority of it
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