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Referring to acca past exam question, mar/june 2019 sample paper.
q3 corfe co
The following information has been taken from the statement of financial position of Corfe Co, a listed company:
$m $m
Non-current assets 50
Current assets
Cash and cash equivalents 4
Other current assets 16 20 ––– –––
Total assets 70 –––
Equity and reserves
Ordinary shares 15
Reserves 29 44 –––
Non-current liabilities
6% preference shares 6
8% loan notes 8
Bank loan 5 19 ––– –––
Current liabilities 7 –––
Total equity and liabilities 70 –––
The ordinary shares of Corfe Co have a nominal value of $1 per share and a current ex-dividend market price of $6·10
per share. A dividend of $0·90 per share has just been paid.
The 6% preference shares of Corfe Co have a nominal value of $0·75 per share and an ex-dividend market price of
$0·64 per share.
The 8% loan notes of Corfe Co have a nominal value of $100 per loan note and a market price of $103·50 per loan
note. Annual interest has just been paid and the loan notes are redeemable in five years’ time at a 10% premium to
nominal value.
The bank loan has a variable interest rate.The question mentions that the bank loan has a variable interest rate. May I know why we include in wacc it will become 7.44%? How to calculate the 7.44%?
Thanks
As the examiners answer states, we have no choice but to use the cost of the loan notes as also being the cost of the bank loan (on the assumption that investors regard them as having the same risk).
The cost of the loan notes is calculated as the IRR of the flows for the loan notes as show in the answer (and as explained in my free lectures).
Dear John,
Hope you are fine. I am fine with the calculation of this question. I just have a question about calculation of cost of equity.
As far as I understood, anyway that we use for calculation of cost of equity should give the same result. By using the CAPM model, the cost of equity = 12%, but if we use the regular method (dividend/ex div price) it becomes = 90/610 = 14.75%.
Why this method does not give the same result as CAPM?Thanks
This is something the examiner has often asked in questions, and I explain in my lectures.
In theory they would give the same result. However in practice they are unlikely to and the reason is that when using what you refer to as the regular method, uses shareholders expectation of future dividends and it is impossible to accurately estimate shareholders expectation of future dividends.
CAPM is regarded as giving a better estimate of the cost of equity (subject to being able to calculate the beta factor).
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