Question

Calculate the company cost of capital (or WACC) of Kangas Ltd, a company that commenced operations many years ago. Relevant details relating to the company include the following. Extract from statement of financial performance Liabilities Debentures ($100 par, 12.5% coupon—annual) $4,000,000 Preference shares ($3 par, 7% cumulative) 1,500,000 Owners’ equityOrdinary shares ($0.50 par) $7,500,000 Retained earnings 2,500,000 Additional information •An interest payment in relation to the debentures has just been made, and they mature three years from today. The market rate of interest on the debentures is 15%. (Use this to calculate the market value of the debt.) •The preference shares are trading on the market at $3.00, and a dividend of 21¢ per share has just been paid. •Forecasts in relation to market returns are as follows: expected risk-free rate of return = 6.5%; expected return on the market portfolio = 16.0%; and the systematic risk of Kangas ordinary shares is the same as the market portfolio’s systematic risk. These shares are trading on the market at $0.63 each.

Answer 1

cost of equity =risk free rate + beta ( market return- risk free rate)

=6.5%+1*(16%-6.5%)

=16%

no of shares of equity =(7500000/0.5)

=15000000

market value of equity= no of shares* market price

=15000000*0.63

=9,450,000

cost of preference shares =dividend/ share price

=0.21/3

=7%

market value of preference = 1500000*3

=4,500,000

market price of debentures

no of debentures = 4000000/100=40,000

market value of debenture =40,000*94.29

=3,771,600

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