Question 3 OR (b)
WACC at book and market value weights
7 marks
- Time to write
- About 14 minutes
From an older CBCS paper
Question
Question 3 OR (b) · 7 marksAlpha Ltd.'s capital structure is:
| Equity share capital (2,40,000 shares) | Rs.48,00,000 |
| 6% Preference shares | Rs.12,00,000 |
| 8% Debentures | Rs.36,00,000 |
| Total | Rs.96,00,000 |
The company's equity share has a market price of Rs. 20. The company is expected to pay a dividend of Rs. 2 per share at the current year's end, growing at 7% for ever. The tax rate is 30%. Using book value weights and market value weights, calculate the weighted average cost of capital.
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 have no market price given; they are taken at book value in the market value weights.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Specific costs 2½ marks 4 min
- 2 WACC at book value weights 2½ marks 4 min
- 3 WACC at market value weights 2 marks 4 min
- Check: arithmetic, units (₹, %), final answer underlined 1 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.
- Equity: Ke = D1 ÷ P0 + g = 2 ÷ 20 + 7% = 17%.
- 6% preference shares: Kp = annual dividend ÷ proceeds, with no tax adjustment because preference dividend is not deductible; no market price is given, so Kp = 6%.
- 8% debentures: Kd = 8% × (1 − 0.30) = 5.60%.
| Source | Book value (₹) | Cost | Weighted cost (₹) |
|---|---|---|---|
| Equity share capital | 48,00,000 | 17.00% | 8,16,000 |
| 6% Preference shares | 12,00,000 | 6.00% | 72,000 |
| 8% Debentures | 36,00,000 | 5.60% | 2,01,600 |
| Total | 96,00,000 | 10,89,600 |
WACC (book) = 10,89,600 ÷ 96,00,000 = 11.35%.
(ii) Market value weights. Equity: 2,40,000 shares × ₹20 = ₹48,00,000. No market prices are given for the preference shares and debentures, so they are taken at book value (paper note). The market values are therefore identical to the book values, and WACC (market) = 11.35% as well.
(Market value weights reflect current prices; here the share price of ₹20 equals the book value per share, 48,00,000 ÷ 2,40,000 = ₹20, so the two weightings coincide.)
Where the 7 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Specific costs | 2.5 |
| 2 | WACC at book value weights | 2.5 |
| 3 | WACC at market value weights | 2 |
| Total | 7 |
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