Question 3 OR (a)
WACC using book value weights
9 marks
- Time to write
- About 18 minutes
- Topic
- Cost of capital
Question
Question 3 OR (a) · 9 marksThe capital structure of Zenith Pvt Ltd is as follows:
Equity Share Capital (of Rs. 10 each): Rs. 18,00,000
11% P reference Share Capital (of Rs. 100 each): Rs. 14,40,000
Retained Earnings: Rs. 24,00,000
15% Debentures (of Rs. 100 each): Rs. 15,60,000
The dividend expected on equity shares is Rs. 7.20 per share, and it is expected to grow at 7% per annum. The share's market price is Rs. 60. Preference shares currently stand at Rs. 75 per share and can be redeemed at par after 10 years. Debentures sell at Rs. 80 per debenture. The rate of income tax is 40%. Using book value weights, calculate the 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
- (i)–(iv)4 items, each marked on its own: give each its share.
- calculateFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
"P reference" and "debenture." are printed with stray spaces and are kept.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Costs of equity and retained earnings 2 marks 4 min
- 2 Cost of redeemable preference shares 2 marks 4 min
- 3 Cost of debentures 2 marks 3 min
- 4 Book weights and WACC 3 marks 5 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Try it first. About 18 minutes for 9 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 shares: ke = D1 ÷ P0 + g = 7.20 ÷ 60 + 7% = 12% + 7% = 19%.
- Retained earnings: the opportunity cost to shareholders, equal to ke without flotation costs: kr = 19%.
- 11% preference shares, redeemable at par (₹100) after 10 years, price ₹75: kp = [D + (RV − P) ÷ n] ÷ [(RV + P) ÷ 2] = [11 + (100 − 75) ÷ 10] ÷ [(100 + 75) ÷ 2] = 13.5 ÷ 87.5 = 15.43%.
- 15% debentures (no redemption terms given, so treated as irredeemable), price ₹80; interest is tax deductible: kd = I(1 − t) ÷ P = 15 × 0.60 ÷ 80 = 11.25%.
| Source | Book value (₹) | Cost | Weighted cost (₹) |
|---|---|---|---|
| Equity share capital | 18,00,000 | 19.00% | 3,42,000.00 |
| 11% Preference share capital | 14,40,000 | 15.43% | 2,22,171.43 |
| Retained earnings | 24,00,000 | 19.00% | 4,56,000.00 |
| 15% Debentures | 15,60,000 | 11.25% | 1,75,500.00 |
| Total | 72,00,000 | 11,95,671.43 |
Where the 9 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Costs of equity and retained earnings | 2 |
| 2 | Cost of redeemable preference shares | 2 |
| 3 | Cost of debentures | 2 |
| 4 | Book weights and WACC | 3 |
| Total | 9 |
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