Question

Suppose company ZZ has issued 10 million shares which are trading at GHS 5 each; 4 million preference shares at GHS 4 and 1,500 bonds at GHS 10,000 each.

1. What is this company’s capital structure?
2. What is the minimum amount that ZZ must generate annually to satisfy its 3 classes of investors, if the coupon rate on the bonds is 20%, the dividend rate on the preference shares is 24% and equity holders require 30% on their investment? The company’s tax rate is 25%.  
3. What is the weighted average cost of capital of ZZ?

Answer 1

(a) Company’s Capital Structure:

Type of Stock	Number	Price each (GHS)	Total Value
Equity Shares	10 millions	5	50 millions
Preference Shares	4 millions	4	16 millions
Bonds	1500	10000	15 millions
Total	81 millions

(b) Minimum amount ZZ must generate:

Coupon rate of the bonds = 20%

Dividend rate on Preference Shares = 24%

Dividend rate on Equity Shares = 30%

Tax rate = 25%

Interest on Bonds = GHS 15 millions*20% = GHS 3 millions

Dividend on Preference Shares:

Rate (before tax) = 24/0.75 = 32%

Amount of dividend = GHS 16 millions*32% = GHS 5.12 millions

Dividend on Equity Shares:

Rate (before tax) = 30/0.75 = 40%

Amount of dividend = GHS 50 millions*40% = GHS 20 millions

Total Income (before tax) require to generate by ZZ for paying

= GHS 5.12 millions + GHS 20 millions + GHS 3 millions

= GHS 28.12 millions

(c) Calculation of Weighted average cost of capital:

WACC = Wd*Kd+We*Ke+Wp*Kp

Where, Kd = 20(1-0.25) = 15%

= 15/81*15+16/81*24+50/81*30

= 26.04%