Question

ABC Limited has the following book value capital structure:

Equity Share Capital (150 million shares, 10 par)
1,500 million Reserves and Surplus
2250 million 10.5% Preference Share Capital (1 million shares, . 100 par)
100 million 9.5% Debentures (1.5 million debentures, 1,000 par)
1,500 million 8.5% Term Loans from Financial Institutions
500 million The Debentures of ABC Limited are redeemable after three years and are quoting at 981.05 per debenture. The applicable income tax rate for the company is 35%.
The current market price per equity share is 60. The prevailing default - risk free interest rate on 10-year GOI Treasury bond is 5.5%. The average market risk premium is 8%. The beta of the company is 1.1875.
The preferred stock of the company is redeemable after 5 years is currently selling at ₹ 98.15 per preference share.
Required:
(i) Calculate weighted average cost of capital of the company using market value weights.
(ii) Define the marginal cost of capital schedule for the firm if it raises 750 million for a new project. The firm plans to have a target debt to value ratio of 20%. The beta of new project is 1.4375. The debt capital will be raised through term loans. It will carry interest rate of 9.5% for the first 100 million and 10% for the next 50 million.

Answer 1

To calculate the weighted average cost of capital (WACC) of ABC Limited, we need to determine the market value weights of each component of the capital structure.

Step-by-step explanation:

(i) To calculate the weighted average cost of capital (WACC) of ABC Limited, we need to determine the market value weights of each component of the capital structure. The market value weight is calculated by dividing the market value of each component by the total market value of all components. Let's calculate it step by step:

1. Equity Share Capital: Market value weight = (Number of shares * Market price per share) / Total market value
2. Reserves and Surplus: Market value weight = Market value / Total market value
3. Preference Share Capital: Market value weight = (Number of shares * Market price per share) / Total market value
4. Debentures: Market value weight = (Number of debentures * Market price per debenture) / Total market value
5. Term Loans: Market value weight = Market value / Total market value

Once we have calculated the market value weights, we can calculate the WACC using the formula:

WACC = (Equity cost of capital * Equity market value weight) + (Debt cost of capital * Debt market value weight)