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I am ACCA student and preparing P4 exam for December 2017 I have question below, please help me out to solve this question for me.
Global plc has two divisions of equal size: a ship building and an oil-rig construction division. The company has a beta equity of 1.890 and a capital structure containing 45% debt finance at an average pre-tax cost of 7%.
The risk-free interest rate is 5% and the market return is 12%. Corporation tax is at 30% and debt finance can be assumed to be approximately risk-free.
The average beta equity of ship builders is 2.250 and the average debt-equity ratio is 2:5.Calculate a suitable risk-adjusted WACC that Global’s oil-rig division can use in NPV analysis of a new investment.
This is explained in full in my free lectures on CAPM (and the F9 lectures on CAPM as well, because it is revision from F9).
You need to calculate the asset beta of Global using the asset beta formula.
Then you need to calculate the asset beta of oil-rig construction using the fact that the overall beta is the weighted average of the individual betas (and you know the overall beta and you know the beta of ship-building).Then you can calculate an equity beta for oil-rig construction using the asset beta formula ‘backwards’, and then you can calculate the WACC in the normal way.
I try to solve the question according to your steps to follow, would you please check the calculations and WACC I calculated is correct.?
1. Asset beta of Global plc
ßa (Global plc) = 1.2022. Asset beta of Ship Building
ßa (Ship Building) = 1.7583. Asset beta of Oil-rig construction
ßa (Global plc) = ßa (Ship Building) x 0.5 + ßa (Oil-rig) x 0.5
ßa (Oil-rig) 0.6464. Equity beta of Oil-rig construction
ßa (Oil-rig) = 1.0155. Cost of Equity
Ke = rf+(rm-rf)*ße
Ke = 5%+(12%-5%)x1.015
Ke = 12.11%6. Cost of Debt (Post-tax)
Kd = Cost of Debt (Pre-tax) x (1-T)
Kd = 7% x (1-0.3)
Kd = 4.90%7. Risk-adjusted WACC
WACC = 9%
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