WACC

Elect Co is a stock?market listed manufacturing company that is seeking additional finance of $5m to undertake a new project. The finance director of Elect Co is currently considering whether to raise the capital via debt or equity finance.
The capital structure of the company (before the new finance has been raised) is as follows:
$m $m
Equity
Ordinary shares (nominal value 50c per share) 10
Reserves 30
40
Debt
Loan note A (nominal value $100 ) 10
Bank loan 5
––– 15

The ordinary shares are currently trading at $1.70 each. The company’s cost of equity hasbeen estimated at 15%.
Loan note A has a current market value of $9.12m and an after tax cost of 7.65%.
The bank loan is repayable in two years’ time. The cost of the bank loan is 2.8%.
Some initial enquiries made by the finance director have indicated that further fixed rate
debt finance could be raised at an annual post?tax cost of 7%. Floating rate debt finance
could be obtained for LIBOR + 2%. Market experts are divided over the expectations of
future interest rates with some expecting rates to remain steady for the foreseeable future
and others predicting an increasing of up to 4%.
Required:
(a) Evaluate the impact on the weighted average cost of capital of raising the new
finance via:
(i) Equity
(ii) Fixed rate debt

ANSWER :

(i) Assuming that the new equity finance does not affect the market value of each
existing share, the impact on the WACC can be estimated as:
WACC = 12.6%

(ii) Assuming that the additional debt finance does not result in a change to the
cost of equity, the impact on the WACC can be estimated as:
WACC =11.8%

I am not getting how the answer has been calculated ? Can you please help solve me this problem