Question 3 (a)
WACC at book and market value weights
8 marks
- Time to write
- About 16 minutes
From an older CBCS paper
Question
Question 3 (a) · 8 marksFrom the information below, calculate the Weighted Average Cost of Capital (WACC) by both book value and market value weights:
| Rs. | |
|---|---|
| 8% Term loan | 14,40,000 |
| 9% Cumulative preference share capital | 3,60,000 |
| Equity share capital (1,20,000 shares) | 12,00,000 |
| Retained earnings | 18,00,000 |
| Total | 48,00,000 |
The equity shares' market value is Rs. 30 per share. Every year the company pays a constant dividend of Rs. 3 per share. Assume tax rate @ 35%. 8
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
- Assume tax rate @ 35%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 dividend is constant, so the cost of equity is dividend over market price. Retained earnings take the cost of equity, and in market value weights they are combined with equity at its market value (C2). The term loan and preference capital are taken at book value in both weightings.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Specific costs 2 marks 4 min
- 2 WACC at book-value weights 3 marks 5 min
- 3 WACC at market-value weights 3 marks 5 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Try it first. About 16 minutes for 8 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: the dividend is constant, so Ke = D ÷ P0 = 3 ÷ 30 = 10% (paper note).
- Retained earnings: they have an opportunity cost to shareholders equal to the cost of equity: 10%.
- 9% preference shares: Kp = 9% (no market price given; dividends are not tax-deductible).
- 8% term loan: Kd = 8% × (1 − 0.35) = 5.20%.
| Source | Book value (₹) | Cost | Weighted cost (₹) |
|---|---|---|---|
| 8% Term loan | 14,40,000 | 5.20% | 74,880 |
| 9% Preference shares | 3,60,000 | 9.00% | 32,400 |
| Equity share capital | 12,00,000 | 10.00% | 1,20,000 |
| Retained earnings | 18,00,000 | 10.00% | 1,80,000 |
| Total | 48,00,000 | 4,07,280 |
WACC (book) = 4,07,280 ÷ 48,00,000 = 8.48%.
(ii) Market-value weights. The market value of the equity, 1,20,000 × ₹30 = ₹36,00,000, belongs to the shareholders' whole interest, share capital and retained earnings together, so the two are combined in one row (paper note); the term loan and preference capital are taken at book value. Market-value weights reflect current conditions.
| Source | Market value (₹) | Cost | Weighted cost (₹) |
|---|---|---|---|
| 8% Term loan | 14,40,000 | 5.20% | 74,880 |
| 9% Preference shares | 3,60,000 | 9.00% | 32,400 |
| Equity (including retained earnings) | 36,00,000 | 10.00% | 3,60,000 |
| Total | 54,00,000 | 4,67,280 |
WACC (market) = 4,67,280 ÷ 54,00,000 = 8.65%.
Where the 8 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Specific costs | 2 |
| 2 | WACC at book-value weights | 3 |
| 3 | WACC at market-value weights | 3 |
| Total | 8 |
Report a problemopens an email to admin@getkunji.com with the question ID7035-Q3aalready filled in.