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Dear John,
I have both questions related to Sep/Dec 2015 past paper.
1. Can you please explain how the examiner calculate combined cost of capital of 9 % in Cigno Co. Just show me the workings of Combined cost of Capital. i did understand everything till combined cost of equity.
2. John please explain in Armstrong Group Q 2 how to examiner calculate the exchange rate for $ i.e 12.17 , 3.97, 3.88, 19.78 and so on…… and how the figures in table came. Can you show me 12.17 and 2.98 workings.
1. The cost of equity is 11.86%
The pre-tax cost of debt is 6.0% from the question, so with tax at 22%, the post-tax cost of debt is 6.0% x (1 – 0.22) = 6% x 0.78.The MV of equity is 60% of the total and the MV of debt is 40%.
So the WACC (calculated in the normal way) = (60% x 11.86%) + (40% x 6% x 0.78) = 8.98%
2. There are certainly no workings for the $12.17 because the question tells you that the amount owed from Armstrong to Horan is US$12.17!!
With regard to the 3.97, the question says that Horan owes Goffen D Kr 16.35
The exchange rate (from the question) is 1 US$ = D Kr 5.4855
Therefore the amount owed in US $ = 16.35/5.4855 = 2.98(Or, if you prefer, the exchange rate is also given the other way round in the question, as 1 D Kr = US $ 0.1823
So D Kr 16.35 = 16.35 x 0.1823 = US $ 2.98 )But John what i dont understand is this. The combined company asset beta is calculated by weighted average of asset betas. Then equity beta is calculated based on it( based on relative gearings).
Why WACC is used for combined company cost of capital ? i guess i missing something here.
How we ascertain in the end after grearing and regearing betas WACC is used to estimate cost of capital. ?
The cost of capital for any company is the WACC.
To be able to calculate the cost of capital we need to know the cost of equity, cost of debt, and proportions of equity and debt.
Here, because of combining the companies, the equity beta changes (and therefore the cost of equity) and we calculate this by ungearing, combining, and regearing the betas.
For the value attributable to shareholders part, why is the MV of debt included in the calculation? i’ve read your answer on a post that asked the same question as i did, you said “ if you want substract debt for both, the difference is still 128m”.
however, i tried to do it as you said,
60000×60% + 31884 + 5594 – 60000×60% – 21000(MV of E of anatra), which got me $16478…can you please explain further?I don’t understand where your figures are coming from.
The total value of the business after unbundling is 37,478. The total current value (plus the premium ) is 37,350. Therefore the increase in 128 and this, of course, belongs to the shareholders.
By all means subtract the same amount of debt from both figures, and because you subtract the same amount, the difference will remain 128.
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