Forums › ACCA Forums › ACCA FM Financial Management Forums › What is cost of debt in this WACC calculation?
 This topic has 5 replies, 2 voices, and was last updated 3 months ago by John Moffat.

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June 7, 2022 at 2:17 pm #657700lookinout
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This is a part from Froste Co example.
“Bond A will be redeemed at nominal value in ten years’ time and pays annual interest of 9%. The cost of debt of this bond is 9·83% per year.
The current ex interest market price of the bond is $95·08. Bond B will be redeemed at nominal value in four years’ time and pays annual interest of 8%. The cost of debt of this bond is 7·82% per year.
The current ex interest market price of the bond is $102·01. Froste Co has a cost of equity of 12·4%. Ignore taxation.”
Now, the the requirement is to calc. WACC. Which debt costs (there are two bond costs) to use in the WACC?
June 7, 2022 at 3:26 pm #657716John MoffatKeymaster Topics: 57
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Without being able to see the question itself, going on what you have typed you would calculate the weighted average of all three sources – equity, bond A, and bond B. Most times in the exam there is just equity and one type of debt borrowing, but on several occasions there have been three sources as in this question.
(Surely you have an answer in the same book in which you found the question, in which case it should be clear from the answer how they have calculated the WACC? )
June 8, 2022 at 5:36 am #657841lookinout Topics: 6
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They give the answer – just one WACC figure without workings – 11.9%
Here’s the full question (I only need WACC workings help):
This scenario relates to three requirements.
Froste Co has a dividend payout ratio of 40% and has maintained this payout ratio for several years. The current dividend per share of the company is $0.50 per share and it expects that its next dividend per share, payable in one year’s time, will be $0.52 per share.
The capital structure of the company is as follows:
$m$m
Equity
Ordinary shares (nominal value $1 per share) 25
Reserves 35
60Debt
Bond A (nominal value $100 20
Bond B (nominal value $100) 10
3090
Bond A will be redeemed at nominal value in ten years’ time and pays annual interest of 9%. The cost of debt of this bond is 9·83% per year. The current ex interest market price of the bond is $95·08. Bond B will be redeemed at nominal value in four years’ time and pays annual interest of 8%. The cost of debt of this bond is 7·82% per year. The current ex interest market price of the bond is $102·01. Froste Co has a cost of equity of 12·4%. Ignore taxation.
June 8, 2022 at 8:51 am #657877John MoffatKeymaster Topics: 57
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You need to calculate the total MV of the equity in the normal way using the dividend growth formula, and the total MV is 154.76M.
Therefore the total MV of the company is 154.76 + 19 + 10.2 = 183.96M.
Then calculate the WACC in the normal way as (154.76/183.96 x 12.4) + (19/183.96 x 9.83) + (10.20/183.96 x 7.82) = 11.9%
I assume that you have watched my free lectures on all of this? 🙂
June 10, 2022 at 9:36 am #658281lookinout Topics: 6
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Thanks for your time!
June 10, 2022 at 2:53 pm #658314John MoffatKeymaster Topics: 57
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You are welcome 🙂

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