Question 2 OR (b)
WACC at book-value and market-value weights
11 marks
- Time to write
- About 22 minutes
From an older CBCS paper
Question
Question 2 OR (b) · 11 marksUsing book value weights and market value weights, calculate Prashant Ltd.'s overall cost of capital from the information below: 11
| Book Value (₹) | Market Value (₹) | |
|---|---|---|
| Equity Shares of ₹ 10 each | 4,80,000 | 7,68,000 |
| 12% Preference Shares of ₹ 100 each (Redeemable at par in 10 years) | 1,20,000 | 90,000 |
| 11% Debentures of ₹ 100 each (Redeemable at par in 5 years) | 3,00,000 | 2,70,000 |
| Reserves | 1,20,000 | — |
The company paid a dividend of ₹ 2.20 per share last year, and it is expected to declare ₹ 2.42 per share. It has kept up this growth rate in dividends over the years, and is expected to keep doing so in future. The tax rate is 40%.
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- calculateFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
The debentures and preference shares are redeemable at par as stated. Reserves have no market value and are combined with equity at its market value (C2). The dividend growth rate is the rise from ₹ 2.20 to ₹ 2.42.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Growth rate and cost of equity 2 marks 4 min
- 2 Costs of preference shares and debentures 3 marks 6 min
- 3 WACC at book-value weights 3 marks 5 min
- 4 WACC at market-value weights 3 marks 5 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Try it first. About 22 minutes for 11 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
- Equity and reserves. Growth g = (2.42 − 2.20) ÷ 2.20 = 10% (paper note); market price = 7,68,000 ÷ 48,000 = ₹16. Ke = D1 ÷ P0 + g = 2.42 ÷ 16 + 10% = 25.125%. Reserves take the same cost.
- 12% preference shares, redeemable at par in 10 years, price 90,000 ÷ 1,200 = ₹75 (no tax adjustment): Kp = [12 + (100 − 75) ÷ 10] ÷ [(100 + 75) ÷ 2] = 14.5 ÷ 87.5 = 16.57%.
- 11% debentures, redeemable at par in 5 years, price 2,70,000 ÷ 3,000 = ₹90 (interest tax-deductible): Kd = [11 × 0.60 + (100 − 90) ÷ 5] ÷ [(100 + 90) ÷ 2] = 8.6 ÷ 95 = 9.05%.
| Source | Book value (₹) | Cost | Book value × cost (₹) |
|---|---|---|---|
| Equity shares | 4,80,000 | 25.125% | 1,20,600 |
| 12% Preference shares | 1,20,000 | 16.57% | 19,885.71 |
| 11% Debentures | 3,00,000 | 9.05% | 27,157.89 |
| Reserves | 1,20,000 | 25.125% | 30,150 |
| Total | 10,20,000 | 1,97,793.60 |
WACC (book) = 1,97,793.60 ÷ 10,20,000 = 19.39%.
(b) Market-value weights. Reserves have no market value of their own; the equity's market value of ₹7,68,000 covers both, and is split between share capital and reserves in the ratio of their book values, 4: 1 (paper note). Both parts cost 25.125%, so the split does not change the result.
| Source | Market value (₹) | Cost | Market value × cost (₹) |
|---|---|---|---|
| Equity shares (4/5 of 7,68,000) | 6,14,400 | 25.125% | 1,54,368 |
| 12% Preference shares | 90,000 | 16.57% | 14,914.29 |
| 11% Debentures | 2,70,000 | 9.05% | 24,442.11 |
| Reserves (1/5 of 7,68,000) | 1,53,600 | 25.125% | 38,592 |
| Total | 11,28,000 | 2,32,316.40 |
WACC (market) = 2,32,316.40 ÷ 11,28,000 = 20.60%.
Where the 11 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Growth rate and cost of equity | 2 |
| 2 | Costs of preference shares and debentures | 3 |
| 3 | WACC at book-value weights | 3 |
| 4 | WACC at market-value weights | 3 |
| Total | 11 |
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