Question

The balance sheet of Murdoch Pty Ltd as at 30 June 2019 reveals the following information: $(‘000s) Paid-up Capital (1,000,000 shares) 3,000 Bank Overdraft 1,000 Accounts Payable 1,500 Mortgage Bonds, $1,000 face value (10%) 4,000 You are also given the following additional information about the firm: a) The company’s marginal tax rate is 30 cents in a dollar. The proportion of tax collected from the company that is claimed by shareholders is 0.6. b) The market price per mortgage bond is $1,000. The bonds mature 10 years from today and the next interest payment is due in six months. c) The financial press advises that short-term overdraft rates are currently 12% per annum compounded daily. The company has been using bank overdraft in the past ten years. d) The most recent annual dividend for ordinary shares was 40 cents. The company’s dividends are fully franked and the dividends per share should continue to increase at a 6 percent growth rate into the indefinite future. The market price of the shares is currently $5.80; however, issue costs of 50 cents per share are expected if new shares are issued. Clearly show the relevant cost of capital for each source of finance and compute the weighted average cost of capital (WACC) for the company. State any assumptions that may be necessary.

Answer 1

Cost of Equity

recent dividend (D0)= 0.40

Current Stock price(P0)=5.80

Dividend Growth Rate= 6%

Cost of Equity= D1/P0+G => D0(1+G)/P0 + G

                    = 0.4(1+6%)/5.8    + 6%   => 0.424/5.8 + 6% => 7.31% + 6%

Cost of Equity= 13.31%

Cost of Debt

The market price of the bond is equal to the face value of the bond= $1000

Cost of Debt= 10%

Marginal Tax rate= 30%

Total value of Debt= 4000 bonds with market price 1000$ means 4000000$

Total value of Equity=1000000 with currennt price 5.84 means8 5800000$

Weight of Equity= 5800000/9800000 => .59

Weight of debt= 1-weight of equity= .41

Wacc= Weight of Equity * Cost of equity + Weight of Debt* Cost of Debt (1-Tax)

         = 0.59*13.31% + .41 * 10%(1-30%)

         = 7.85% + 2.87%

         =10.72%

Value of Wacc= 10.72%