Question 3 (b)
WACC, and revised WACC after a new term loan
7 marks
- Time to write
- About 14 minutes
From an older CBCS paper
Question
Question 3 (b) · 7 marksThe figures below are taken from a company's current balance sheet:
| Equity share capital | ₹ 48,00,000 |
| 12% Preference shares | ₹ 4,80,000 |
| 10% Debentures | ₹ 7,20,000 |
The company's equity shares are quoted at ₹110, and it is expected to declare a dividend of ₹ 15 per share. The dividend's rate of growth, 8%, is expected to be maintained. Assuming tax rate @ 40%.
Calculate the Weighted Average Cost of Capital. (WACC)
The company wishes to raise an additional term loan of ₹ 6,00,000 at 10%. Assuming the market price of equity share has fallen to ₹ 105, calculate the revised WACC.
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
- Assuming tax rate @ 40%The paper fixes this: use it as given, and say so in your answer.
- CalculateFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
The number and face value of the equity shares are not given, so the weights are the book values printed; the market-price figures are used only for the costs. The revised WACC adds the new loan to the book structure.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Specific costs 2 marks 3 min
- 2 WACC 2 marks 3 min
- 3 Revised cost of equity and WACC 3 marks 5 min
- Check: arithmetic, units (₹, %), final answer underlined 2 min
Try it first. About 14 minutes for 7 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.
Basis (paper note): the number of equity shares and their face value are not given, so the weights are the book values printed; the market price enters only the cost of equity. Tax 40%.
- Equity: Ke = D1 ÷ P0 + g = 15 ÷ 110 + 8% = 21.64%.
- 12% preference shares: no market price is given, so Kp = 12%; dividends are not tax-deductible.
- 10% debentures: Kd = 10% × (1 − 0.40) = 6%.
| Source | Book value (₹) | Cost | Weighted cost (₹) |
|---|---|---|---|
| Equity share capital | 48,00,000 | 21.64% | 10,38,545.45 |
| 12% Preference shares | 4,80,000 | 12.00% | 57,600 |
| 10% Debentures | 7,20,000 | 6.00% | 43,200 |
| Total | 60,00,000 | 11,39,345.45 |
WACC = 11,39,345.45 ÷ 60,00,000 = 18.99%.
(ii) Revised WACC. The new term loan of ₹6,00,000 at 10% costs 6% after tax. With the share price at ₹105, Ke = 15 ÷ 105 + 8% = 22.29%.
| Source | Book value (₹) | Cost | Weighted cost (₹) |
|---|---|---|---|
| Equity share capital | 48,00,000 | 22.29% | 10,69,714.29 |
| 12% Preference shares | 4,80,000 | 12.00% | 57,600 |
| 10% Debentures | 7,20,000 | 6.00% | 43,200 |
| 10% Term loan | 6,00,000 | 6.00% | 36,000 |
| Total | 66,00,000 | 12,06,514.29 |
Revised WACC = 12,06,514.29 ÷ 66,00,000 = 18.28%.
The cheaper debt lowers the WACC even though the fall in the share price (a sign of the greater risk to shareholders) raises the cost of equity.
Where the 7 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Specific costs | 2 |
| 2 | WACC | 2 |
| 3 | Revised cost of equity and WACC | 3 |
| Total | 7 |
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