1Weighted Average Cost of Capital1.A.Using the Dividend Valuation Model, we can arrive at the cost of equity as follows:As dividends for past 5 years has been given, we shall use Dividend Valuation Model to arriveat the cost of equity. This model uses the historic data to arrive at growth rate of dividends.Ke = [D0 (1+g) / P0)] + g ,where, Ke = cost of equity; D0 = current level of dividend; P0 = Current Share Price; g = estimated growth rate in dividendsGiven, D0 = $0.137; P0 = $1.42; g = (D0/Dividend n years ago)1/2 - 1where, n = 5 years; Dividend 5 years ago = $0.1g = (0.137/0.1)1/2 - 1 = 0.1705 or 17.05%Therefore, Ke = [0.137 (1+0.1705)/1.42] + 0.1705Ke = 0.2834 or 28.34%B.We can arrive at the cost of debenture as follows:The par value of debentures to arrive at the cost is taken as $100 per debenture.Kd = I / Po, where I = Annual Interest Paid; Po = ex interest market value of the debt Given, I = 7% of $100 = $7; Po = $76Therefore, Kd = 7/76 = 9.21%C.Cost of Long Term Loan = 15% + 1.5% = 16.5% (Given)Weighted Average Cost of Capital:It is the cost of different sources of capital multiplied by the proportion of such source of capitalagainst the entire capitalFor the given scenario, it shall beWACC = (Ke * We) + (Kd * Wd) + (Kl * Wl)Where, Ke = cost of equity; kd = cost of debt; kl = cost of Long Term LoanWhere, We = weightage of equity; Wd = weightage of debt; Wl = weightage of Long Term Loan
2TypeAmount as at31 Dec 2009Cost of CapitalWeightageProduct7% Debentures7,30,0009.21%35.10%3.23Long Term Loan8,50,00016.5%40.86%6.74Capital and Reserves5,00,00028.34%24.04%6.81Total20,80,000100%16.78Therefore, the WACC of XYZ Ltd is 16.78%.2.Weighted Average Cost of Capital (if corporate tax rate at 30%):Cost of Equity would remain same at 28.34% as the tax rate does not affect the earning ofequity shareholders. However, it shall vary for the interest bearing capital, being recomputed asfollows:Kd = 7(1-0.3)/76 = 4.9/76 = 6.45%Kl = 16.5% * (1-0.3) = 11.55%(The effect of tax has been removed to arrive at the respective cost of capital.)TypeAmount as at31 Dec 2009Cost of CapitalWeightageProduct7% Debentures7,30,0006.45%35.10%2.26Long Term Loan8,50,00011.55%40.86%4.72Capital and Reserves5,00,00028.34%24.04%6.81Total20,80,000100%13.79Therefore, the WACC of XYZ Ltd is 13.79%.