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The equity beta of ABC PLC 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.
ABC PLC 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, XYZ Co. The equity beta of XYZ Co is 1.2 and the company has an equity market value of $54 million. The market value of the debt of XYZ 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 ABC PLC.
b) Calculate a cost of equity which could be used in appraising the new project.
None of this is examinable in Paper FA – it is Paper FM and you should ask in the Paper FM Ask the Tutor Forum.
However there is no point in simply typing out a full question in expecting to be provided with a full answer. You must have an answer in the same book in which you found the question and so you should ask about whatever it is in the answer that you are not clear about.
Everything needed to be able to answer this question is covered in our free Paper FM lectures. 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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