Question 3 (b)

WACC on the existing capital structure

9 marks

Time to write: About 18 minutes
Topic: Cost of capital

Question

Question 3 (b) · 9 marks

Clear view company's capital structure on 1 July 2024 is as follows:

Equity Shares (4,80,000)	₹ 1,08,00,000
10% Preference Shares	24,00,000
10% Debentures	72,00,000
	2,04,00,000

The company's share currently sells at ₹25. The company is expected to pay a dividend of ₹2.50 per share, growing at 7 percent forever. Assume a tax rate of 30 percent. Compute a weighted average cost of capital on the existing capital structure.

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

18 minfor 9 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

"Equity Shares (4,80,000)" is read as the number of equity shares. The weights are the book values given (the "existing capital structure"); the share price is used for the cost of equity.

Write it in this order

Read the data; note exactly what is asked 1 min
1 Cost of equity dividend growth 2 marks 4 min
2 Costs of preference shares and debt after tax 2 marks 3 min
3 Weights and WACC 5 marks 9 min
Check: arithmetic, units (₹, %), final answer underlined 1 min

123

Short on time? Step 3 carries 5 of the 9 marks: guard its minutes.

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.

Specific costs

Equity: with a constant growth in dividends, ke = D1 ÷ P0 + g = 2.50 ÷ 25 + 7% = 10% + 7% = 17%.
10% preference shares: kp = 10% (dividend rate; no price given).
10% debentures: interest is tax deductible, so kd = 10% × (1 − 0.30) = 7%.

Weighted average cost of capital (book values of the existing structure as weights, paper note)

Source	Amount (₹)	Cost	Weighted cost (₹)
Equity shares	1,08,00,000	17%	18,36,000
10% Preference shares	24,00,000	10%	2,40,000
10% Debentures	72,00,000	7%	5,04,000
Total	2,04,00,000		25,80,000

WACC = 25,80,000 ÷ 2,04,00,000 = 12.65%.

Where the 9 marks sit

#	Component	Marks
1	Cost of equity (dividend growth)	2
2	Costs of preference shares and debt after tax	2
3	Weights and WACC	5
	Total	9

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