Finance Report: WACC, Cost of Capital, and Capital Structure Analysis

Verified

Added on  2022/09/01

|4
|484
|21
Report
AI Summary
This report analyzes the weighted average cost of capital (WACC) for a company considering a new investment, specifically the launch of a low-cost electronic security device. The report calculates the cost of equity, cost of debt, and the WACC based on the provided information and ratios. The cost of equity is calculated to be 4.70%, and the cost of debt is 2.64% after tax adjustments. The WACC is calculated to be 3.83%, which is lower and indicates a higher market value. The report concludes that the company should maintain its existing capital structure, showing the inverse relationship between cost and market value. References supporting the calculations are also included.
Document Page
Running Head: FINANCE 1
FINANCE
tabler-icon-diamond-filled.svg

Paraphrase This Document

Need a fresh take? Get an instant paraphrase of this document with our AI Paraphraser
Document Page
FINANCE
Cost of capital is the capital which can be understood as the required rate of return quite needful
to make a capital budgeting decision. This rate is basically helpful in analyzing the new
proposals, the company wishes to invest in. In this present case of launching of new low-cost
electronic security device, namely Watchdog, the company Chowkidar PLC, wishes to maintain
the existing capital structure and divided the sources of funds into three categories namely cost
of equity, cost of debt and mezzanine finance. As per the calculations it can be seen that each of
them are divided in the given ratio or as weights (Mari and Marra, 2018).
Ratio information
Ratio of bonds 0.59
Ratio of mezzanine finance 0.4
Ratio of equity 0.1
The cost of equity and the cost of debt have been calculated below with the help of the given
information and this also implies that cost of equity is 4.70% whereas the cost of debt is 2.64%
including the adjustment of the tax.
Calculation of cost of equity
Cost of equity (D *(1 + g))/ P + g
Dividend last paid 0.14
Growth Rate 4.55%
Current market price 100
Cost of equity (0.14*(1 + 4.55%))
(100 + 4.55%)
Cost of equity 4.696%
Cost of equity 4.70%
Calculation of cost of debt
YTM= C+(FV-PV)
(FV+PV)/2
Document Page
FINANCE
Coupon rate 4%
Face Value of Bond 100
Coupon per bond 4.00
Time period 7
Market price 91.5
Cost of debt (4 + (100-91.50))
((100+91.50)/2)
Cost of debt 0.0326
Cost of debt 3.26%
Cost of debt 2.64%
With the above calculation, the process of calculating the weighted average cost of capital is
formed and listed below.
Calculation of WACC
Cost of Equity 4.70%
Cost of Debt 2.64%
Cost of Mezzanine Finance 8%
WACC 3.83%
Weighted average cost of capital is 3.83% which is seen to be lower and this also indicates that
the company is having higher market value. This exhibits the inverse relationship between the
cost and the market value. Hence, it is advised to the company to maintain the existing capital
structure (Carluccio, Mazet-Sonilhac and Mésonnier, 2018).
Document Page
FINANCE
References
Carluccio, J., Mazet-Sonilhac, C. and Mésonnier, J.S., (2018) Investment and the WACC: new
micro evidence for France.
Mari, C. and Marra, M., (2018) Valuing Firms Under Default Risk and Bankruptcy Costs: A
WACC-Based Approach. International Journal of Business, 23(2), pp.111-130.
chevron_up_icon
1 out of 4
circle_padding
hide_on_mobile
zoom_out_icon
[object Object]