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Faubney Ltd is a stock-exchange listed company. The capital structure of the company as at 31 December 2015 is as follows:
Rs million Rs million
Equity
Ordinary Shares of Rs2 per share 400
Reserves 300
11% Preference Shares 200
Non-Current Liabilities
Bond X (par value Rs1000) 400
Bond Y (par value Rs1000) 250Faubney Ltd has an equity beta of 1.4. The risk-free rate of return is 4% per year and the average return on the market is 12% per year. Ordinary dividend paid for the year 2015 was Rs120 million. The dividends of the company have grown in recent years by an average rate of 5% per year.
The company issued preference shares at Rs1.25 per share and they are currently traded at Rs1.40 per share.Bond X will be redeemed at par in nine years’ time and pays annual interest of 9%. The current market price of the bond is Rs960. Bond Y will be redeemed at par in four years’ time and pays annual interest of 7.5%. The current market price of the bond is Rs1050
Bond X and Bond Y were issued at the same time. The company pays tax on profit at an annual rate of 20%.
Required:
(a) Calculate the weighted average after-tax cost of capital for Faubney Ltd. Use market values where appropriate.Please do not simply type out test questions and expect me to provide an answer – you must have an answer in the same book in which you found the question. You should ask about whatever it is in the answer that you are not clear about and then I will explain.
The rule for calculating the cost of preference shares is exactly the same as for ordinary shares. However, obviously with preference share the rate of dividend growth is zero because preference shares carry a fixed dividend.
Have you watched my free lectures on the calculations of the cost of equity, cost or debt, and the WACC? The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
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