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The equity beta of Fence Co is 0.9 and the company has issued 10 million ordinary shares.
The market value of each ordinary share is $7.50. The company is also financed by 7%
bonds with a nominal value of $100 per bond, which will be redeemed in seven years’ time
at nominal value. The bonds have a total nominal value of $14 million. Interest on the
bonds has just been paid and the current market value of each bond is $107.14.
Fence Co plans to invest in a project that is different to its existing business operations and
has identified a company in the same business area as the project, Hex Co. The equity beta
of Hex Co is 1.2 and the company has an equity market value of $54 million. The market
value of the debt of Hex Co is $12 million.
The risk-free rate of return is 4% per year and the average return on the stock market is
11% per year. Both companies pay corporation tax at a rate of 20% per year.Required:
(a) Calculate the current weighted average cost of capital of Fence Co.Discount Factor for IRR is choosen as 5% & 4%.
My question is, how do you determine which Discount factor to start with ?
As I explain in my free lectures, it does not. matter what ‘two guesses’ you use (although I do explain the way I think about it in the lecture).
Appreciate however that in Section C questions you do not need to make two guesses anyway because you can use the IRR function on the spreadsheet.
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