Question 3 OR (a)

WACC on the existing capital structure

8 marks

Time to write: About 16 minutes

From an older CBCS paper

Question

Question 3 OR (a) · 8 marks

Suresh Traders Ltd's capital Structure is:

Equity Shares (2,40,000)	48,00,000
10% Preference Shares	12,00,000
10% Debentures	36,00,000
	96,00,000

The company's share currently sells at ₹25. The company is expected to pay a dividend of ₹2 per share, growing at 7% for ever. Assume a tax rate of 30%. On the existing capital structure, you are required to compute a 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

16 minfor 8 marks

Read from the question

Assume a tax rate of 30%The paper fixes this: use it as given, and say so in your answer.
computeFormula first, then the working, then the answer with its unit (₹, %, units).

What the paper leaves open

The debentures and preference shares are taken at book value with no redemption terms (irredeemable); the 2,40,000 equity shares are the number of shares, and the market price is used for the cost of equity, with book value weights.

Write it in this order

Read the data; note exactly what is asked 1 min
1 Cost of equity 2½ marks 4 min
2 Costs of preference shares and debentures 2 marks 4 min
3 Weighted cost and WACC 3½ marks 6 min
Check: arithmetic, units (₹, %), final answer underlined 1 min

123

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.

Basis (paper note). Book value weights; the 2,40,000 equity shares are the number of shares (book value ₹20 each), and the market price of ₹25 is used for the cost of equity. Debentures and preference shares have no redemption terms and are treated as irredeemable at book value.

Specific costs

Equity: Ke = D1 ÷ P0 + g = 2 ÷ 25 + 7% = 15%.
10% preference shares: Kp = 10% (dividend not tax-deductible).
10% debentures: Kd = 10% × (1 − 0.30) = 7%.

Source	Book value (₹)	Cost	Weighted cost (₹)
Equity shares	48,00,000	15%	7,20,000
10% Preference shares	12,00,000	10%	1,20,000
10% Debentures	36,00,000	7%	2,52,000
Total	96,00,000		10,92,000

WACC = 10,92,000 ÷ 96,00,000 = 11.375% (about 11.38%).

Where the 8 marks sit

#	Component	Marks
1	Cost of equity	2.5
2	Costs of preference shares and debentures	2
3	Weighted cost and WACC	3.5
	Total	8

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