Question

Question 2

Weighted Average Cost of Capital

The capital structure of Minelli Enterprises Limited as at 31 March 2020 is as follows: $’000

Ordinary shares (par value $1.50) 60,000 5.5%

(post-tax) Preference Shares (par value $2.20) 8,800 6.5%

(pre-tax) Bonds semi-annual (par value $1000) 80,000

Term Loan (interest rate 4.25% per annum) 6,500

Additional Information:

• The ordinary shares are currently trading at $1.95 while the preference shares are trading at $2.45.

• Return on government bonds is 1.25%, the market risk premium 4.25%. A consultant has estimated the company to have a beta of 1.30.

• The company tax rate is 28% • The bonds initially had a 5-year term to maturity and were issued exactly three years ago and would be redeemed at par.

• The current market value of the bond is $ 955.

Required:

2.1 Bond ratings are susceptible to the COVID-19 pandemic. Discuss.

2.2 Calculate the post-tax weighted average cost of capital (WACC) for Minelli Enterprises Ltd using the market valuation approach (show all workings).

Answer 1

Answer :

2.1

• Bond ratings are susceptible to COVID 19 Pandemic as the Pandemic may seriously impact the Company's revenue and Operating Profit.
• The reduced economic activity due to the lockdowns, closures, and restrictions on movements has resulted in reduced incomefor most companies.
• Lower revenue decreases the debt service capacity of the companies and therefore, the bond bond ratings may be adversely impacted

2.2

• Weighted average Cost of Capital

	Workings
Bond Value	80,000 * 1,000	8,00,00,000
Par Value	( Given Data )	1,000
Number of Bonds	Bond Value / Par value	80,000
Coupon rate	( Given Data )	6.5%
Market Price	( Given Data )	955
Yield	( ( 1,000 / 955 )0.5 ) - 1	2.33%
Market Value of Bond	80,000 * 955	7,64,00,000

Term Loan	6,500 * 1,000	65,00,000
Interest rate	( Given Data )	4.25%

Ordinary Shares Value	60,000 * 1,000	6,00,00,000
Ordinary Shares Par Value	( Given Data )	1.50
Number of Shares	Share Value / Par Value	4,00,00,000
Price per ordinary share ( E )	( Given data )	1.95
Market Value of Ordinary Shares	1.95 * Number of Shares	7,80,00,000

Preference Shares Value	8,800 * 1,000	88,00,000
Preference Shares par value	( Given Data )	2.20
Number of Shares	88,00,000 / 2.20	40,00,000
Price per preference share ( PE )	( Given Data )	2.45
Market Value of preference shares	2.45 * 40,00,000	98,00,000

Debt ( D )	7,64,00,000 + 65,00,000	8,29,00,000
Ordinary Equity ( E )	( Market Value of Ordinary Shares )	7,80,00,000
Preference Equity ( PE )	( Market Value of Preference Shares )	98,00,000
Total	D + E + PE	17,07,00,000
	D / ( D + E + PE )	0.49
	E / ( D + E + PE )	0.46
	PE / ( D + E + PE )	0.06

Risk free rate ( RF )	( Given data )	1.25%
Beta	( Given Data )	1.30
Market Risk Premium ( MRP )	( Given Data )	4.25%
Cost of Ordinary Equity ( RE )	RF + ( Beta * MRP )	6.35%
Cost of Preferred Equity	( Given Data )	5.50%
Cost of Debt	Weighted average of Bond Yield and term loan interest rate	2.48%
Tax rate		28.00%
Wighted average Cost of Capacity	Weight of debt * after-tax cost of debt + weight of equity * cost of ordinary equity + weight of preference equity * cost of preference equity	4.00%

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