Re: ::: vuaskari.com ::: WACC calculation query!!

fizza baji, hafiz salman bhai, and other vu members,

could u pleasee attempt this question as i am unable to do it, or just explain it to me.

acc501

T & S manufacturer is interested to measure its overall cost of capital. Firm raised capital through long term debt and Common Stocks. Weights of capital structure components are 45% for long term debt and 55% for common stocks. The firm is in the 40% tax bracket.

 

Common Stock: the firm's common stock is currently selling Rs. 500 per share. The firm expects to pay cash dividend Rs. 37.5 per share next year. The firm dividend has been growing at an annual rate of 6% and this rate is expected to continue in the future.

Long term Debt: Firm raised capital by issuing 10 years bonds at par value Rs. 1,000 with 8% coupon rate (coupons are paid annually). Bond is traded at Rs. 900 in market. Cost of debt after tax is 5.80 %.

 

You are required to answer the following:

1. Cost of Common Stock (Provide your answer in percentage and up to two decimal)

2. WACC (Provide your answer in percentage and up to two decimal)

2011/7/2 Fizza Dastgir <mc090405569@vu.edu.pk>

I posted on MDB as well but did not get any answers: I am attaching my query please comment:

On page 151 there is a numerical example regarding calulation of WACCL and rE,L and a table is given under whose row #4 in which debt value is Rs.400 should be the answer to the numerical question. but answer i am getting through calculations for rE,L and WACCL even NI is different from the table. I am attaching the question and the formulae given on page 150 please send me the calculations, as I am not grasping it right.

Thanks.

A 100% Equity Firm (or Un-levered) has Total Assets of Rs.1000. It has a WACCU of 21% and 
rD,U of 10%. It then adds Rs.400 of Debt. Financial Risk increases rD,L of Levered Firm to 13%. What is 
the Levered Firm's rE,L and WACCL ? Tax rate is 30%.

(PLEASE SEE THE TABLE ON PAGE 151, AS ITS NOT BEING COPIED)

Formulae:

E = NI / rE,L 

NI = (EBIT - xD rD) (1 - Tc)

rE,L = WACCU + xD (WACCU - rD ) (1 - Tc).

Traditionalists Formula for WACC: 
WACCL = xD rD (1 - Tc) + xE rE.

Please send me the detailed calculation for the above question as I am unable to calculate.

Another issue to be noticed is that the TAX SHIELD APPROACH given on page 153 claims that it gives the same result as the NI APPROACH but when i trie dto solve the numerical given on page 152 it gave different results from NI Approach solved on page 152-153. can you please clarify why is that so?

For Example:

– If the Firm takes Rs.100 Debt at 10% Interest or Mark-up then what is the WACCL of Levered Firm?

USING NI APPROACH

VU= Rs.350

• Equity 
= NI / rE 
= 63 / 0.2 
= Rs.315 (Major Assumption: No change in rE) 
• VL = Equity + Debt 
= 315 + 100 
= Rs.415. (Increasing Debt ADDS Value!)

USING TAX SHIELD APPROACH

• VL = Equity + Debt

 VL = Vu + Tc D.

= 350 + 0.3(100)

= Rs. 380 which is differet from the answer of VL by NI approach

• Equity

Market Value of Equity = E = VL - D

= 380 - 100 = Rs. 250 which again is different from the answer by NI approach

CAN YOU PLEASE CLARIFY WHY IS THIS SO WHEN ITS TOLD IN THE VIDEO LECTURE THAT BOTH APPROACHES WILL GIVE THE SAME ANSWERS. SECONDLY WHICH TO USE?

Thanks again

--

FIZZA DASTGIR BHATTI

*~*~*~*~*~*~*~*~*~*~*~*

MC090405569 

MBA - ISLAMABAD

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We say, "Be one as Pakistani Nation and grow up for Pakistan's Future". Wish you all the best. Join www.vuaskari.com,
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