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  • Subject Name : Accounting and Finance

Table of Contents

Requirement A:

Requirement B: Calculation of Weighted average cost of Capital (WACC):

Requirement C:

Accounting and Finance - Requirement A

The possible sources of discrepancies that leads to lower cost of capital using DDM method is that CAPM or capital asset pricing model takes into consideration many market factors that dividend discount model does not account for. The CAPM method accounts for RFR based on the yield of a government bond and also considered market risk premium for equities and the beta for a particular company, which leads to a comparatively higher cost of capital as compared to DDM method.

Requirement B: Calculation of Weighted average cost of Capital (WACC):

Following data are provided as follows:

Cost of Equity as required by shareholders= 16.80%

Value Of equity shares of company= 516,000,000

Cost of Bond K= 9.50%

Value Bond K= 249,400,000

Cost of Bond Q= 10.70%

Value of Bond Q= 150,000,000

Value of preference shares= 88,530,000

Cost of Preference Shares= 13%

Cost of Debt= 12.20%

Tax rate= 35%

Calculations are done as follows:

TYPES OF CAPITAL

AMOUNT [A]

WIEGHT [B]

Cost Of capital

Tax Adjustment (Cost of debt * (1-T)) [C]

WACC [B*C]

Value of equity shares of company

516,000,000.00

51.40%

16.80%

16.80%

8.63%

Value of Bond K

249,400,000.00

24.84%

9.50%

6.18%

1.53%

Value of Bond Q

150,000,000.00

14.94%

10.70%

6.96%

1.04%

Value of preference shares

88,530,000.00

8.82%

13%

13.00%

1.15%

Value of Long-Term loan

2,885.00

0.00%

12.20%

7.93%

0.00%

TOTAL VALUE

1,003,932,885.00

100.00%

   

12.35%

In the above calculation we have calculated the weighted average cost of capital of company as 12.35% by considering all of the sources of capital of the company. We have also considered the long-term loan but its value is so low that it will not impact the WACC of the company, because its weight in the company’s capital structure is very low that it has almost become insignificant.

Accounting and Finance - Requirement C

The beta which we have used in the calculation of WACC is 1.12. For different project with different betas we are required to adjust the cost of capital according to the beta of a particular project. Beta represents the level of systematic risk in a project, high beta means risky project and vice versa.

Project H has a beta of 0.66 which is lower than the beta of the company, so we are required to adjust the cost of capital of the company downward to match the riskiness of the project. Similarly, the beta for project L is 2.6 which are way higher than the company beta, i.e. it is a risky project, and thus we will adjust the cost of capital of company upward to account for higher beta of this project. And then we will compare the cost of the project with its expected returns to decide whether to accept or reject a project. The beta of project is adjusted using Pure-play method by un-levering and levering of betas.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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