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Hi , Can you please help me? I am a little confused on which kd should be calculated on which kind of debt if a Co. has several kinds of debt. For example,a co. has convertible debt and bank loan, or say preference shares and or any other form of debt, n we are asked to calculate cost of debt..which debt are we meant to use to calculate cost of debt. Are we meant to calculate Kd for convertible debt, or bank loan? or both? I mean how do we decide? Example of this question is june 08, Q1 Burse Co.
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First of all Burse is about calculating the WACC of Burse.. So to calculate WACC you need to state the basic formula and then proceed to fill in the blanks of the formula. SO WACC states that: Ko = Ke (%) + Kdat (%)
Approach / Procedure in the EXAM
Calculate:
(1) Ke (Cost of Equity)
DVM ( Growth or no Growth in Dividends ? )
P/E model
CAPM(2) Kdat (Cost of Debt)
Redeemable => IRR (NPV # 1, NPV # 2, Interpolate)
IRRedeemable => KDAT = CI (1-t) / MV(3) Weightings
Preferably Market Values***** If you have another type of finace in the capital structure then it’s cost and weighting have to be included also in the REVISED WACC formula, as follows:
Ko = Ke (%) + Kdat (%)+ Kdat (%)
In the case of Burse this was the Bank Loan and as this was a private issue of debt there was no market price of similar risk debt given in the question … so as there were no market values available the easiest thing to do was just use the Book Values.
***** In the case of the Conversion Decision ALWAYS do this first when calculating the KDAT of the Redeemable Debt and if the Conversion Value is better then advise this option… ie.. to convert rather than redeem.
Hope you’ve got it! Kind regards, Peter
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