Weighted average cost of capital

This is the minimum return which management of a Company should bring for its owners.
And it always corresponds with the risk that the providers of finance are taking.

Ordinary shares Cost of equity --- Ke

Preference shares Cost of preference shares --- Kp
Debt (Debentures, bonds, bank loan, overdraft) Cost of debt --- Kd

WACC = [(MVe x Ke) + (MVd x Kd) + (MVp x Kp)]/ (MVe + MVp + MVd) without tax

WACC = [(MVe x Ke) + (MVd x Kd)(1-t) + (MVp x Kp)]/ (MVe + MVp + MVd) with tax

Always look for the balance sheet when WACC is to be calculated.

Look for the conversion in market values.

Share Capital
Share premium
Retained Earnings
Total Equity (BV)
Price to book value
Total Equity (MV)

Debt (MV)

WACC
Equity
Debt

WACC = [(126 Mn x 18%) + (45 Mn x 11%)]/(126

WACC = 16.16%
Market value of debt
Cost of debt

Market value of equity

Cost of equity
Market value of preference shares
Cost of preference shares
 For example: I buy around 2000 shares of Unity Foods Limited @ Rs 45 per share.

= 2,000 x 45 90,000

Whereas the nominal value of shares is Rs 10 (2,000 x 10 = 20,000)

Now the company gave out a dividend of Rs 5 per share

Return calculated by shareholder: 5/45 11%

Return calculated by company: 5/10 50%

50,000,000 Price to book value = Price of equity/Book value of Equity

5,000,000 1.8 = Price of equity / 70,000,000
15,000,000 Price of equity = 70,000,000 x 1.8
70,000,000 Price of equity = 126,000,000
1.80
126,000,000

45,000,000

126,000,000 18% 22,680,000

45,000,000 11% 4,950,000
171,000,000 27,630,000 16.16% WACC

6 Mn x 18%) + (45 Mn x 11%)]/(126 Mn + 45 Mn)

WACC MV Cost
Equity 57,280,000 12.00% 6,873,600
Debt 20,684,000 8.50% 1,758,140
77,964,000 8,631,740

Nominal value of bonds

Nominal value of one bond

Market value of one bond
 Market value of bonds (20 Mn/100*103.42)

Capital structure MV Cost

Equity 168,000,000 16% 26,880,000
Pref shares 40,000,000 13% 5,200,000
Long term loan 50,000,000 7% 3,500,000
Bank OD 10,000,000 5% 500,000
268,000,000 36,080,000 13.46% WACC (36.08 Mn / 268 Mn)

OR it can be calculated through weightage of each item of capital structure

Capital structure MV Weight (MV/Total) Cost Weight x Cost

Equity 168,000,000 62.69% 16% 10.03%
Pref shares 40,000,000 14.93% 13% 1.94%
Long term loan 50,000,000 18.66% 7% 1.31%
Bank OD 10,000,000 3.73% 5% 0.19%
268,000,000 100.00% 13.46%

Working Capital = Current assets - Current Liabilities

NCA + CA = E + NCL + CL
NCA + CA - CL = E + NCL
NCA + CA - CL - NCL = E
157 + 16 - 39 = E
E = 134

Book value of equity 134,000,000

P/B ratio 1.30
Market value of equity 174,200,000
Market value of debt 39,000,000

WACC MV Cost
Equity 174,200,000 12.00% 20,904,000
Debt 39,000,000 8.00% 3,120,000
213,200,000 24,024,000 11.27%

WACC (24.024 Mn / 213.2 Mn)

This is the worng approach

11.07% WACC

20,000,000

100.00
103.42
 20,684,000

C (36.08 Mn / 268 Mn)

WACC
Market Value of Equity:
Method 1: Value of individual components

Land 20,000,000
Construction 10,000,000
Builder margin @10% 1,000,000
Add ons 4,000,000
35,000,000

I want to buy this house: some area in Lahore. Method 2: Value of reference properties

Value of a similar house 70,000,000

Lets say, I buy this property for Rs 70,000,000.

Method 3: Value based on future rent

If you let out this property, you will receive rent in perpetui
Rent: 1 Mn a month x 12 = 12 Mn a year
10% return us required on investment.
PV of future rent = R/i
PV of future rent = 12,000,000/10%

DIVIDEND VALUATION MODEL

DVM states that the MV of a share is the PV of its lifetime dividends. Sales
COGS
For example: Rate of return required by Mr. A is 10%. GP
Now Mr. A is valuing the share of WAVES Expenses
WAVES is paying a constant dividend of Rs 50 per year. OP
Tax @ 30%
PV of dividends = Dividend per year / Cost of Equity PAT
MV (Equity) = Dividend per year / Ke
MV (Equity) = 50/10% Now this Rs 70 is available fo
MV (Equity) = 500 Assuming:
- the cost of equity of this c
The market value of shares of WAVES should be Rs 500 per share. - company distrubutes entir

MV (Equity) = Div / Ke
MV (Equity) = 70 / 10%
MV (Equity) = 700 per share s

Likeiwise for preference shar

MV (Pref) = Pref Div / Kp
In actual, dividend is not constant. Company retains a portion of earning for growth and expansion.

Now we want to study dividend growth model.

 Method 1: Asset based valuation
Method 2: Reference value of similar assets
Method 3: Cash value based valuation
Method 4: Earnings based valuation (Mergers & Acquisitions)

Now lets say, you buy a share of a company.

MV of tne share is to be determined.

Methods to determine the value of equity:

1: Dividend valuation model (MV of equity based on its dividend)

2: Free cash flows model (Mergers and acquisitions)
s 70,000,000.

will receive rent in perpetuity

120,000,000

1,000
(800)
200
(100)
100
(30)
70

ow this Rs 70 is available for dividend distribution.

the cost of equity of this company is 10%.

company distrubutes entire earning as dividend.

V (Equity) = Div / Ke
V (Equity) = 70 / 10%
V (Equity) = 700 per share should be the market value.

eiwise for preference shares:

V (Pref) = Pref Div / Kp

MV (Equity) = Div / Ke
MV (Equity) = 1.70 / 9%
MV (Equity) = 18.89
If a Company is paying a constant dividend of Rs 10 and the Ke is 10%

MV = Div / Ke
MV = 10 / 10%
MV = 100

Alternatively, the Ke can be calculated if the dividend is known and MV is known.

Ke = Div / MV
Ke = 100 / 500
Ke = 20%

If a company is constantly paying a ceratin dividend, what happens?

Dividend = 100% 2018 2019 2020 2021 Dividend = 60%

Sales 10,000 10,000 10,000 10,000 Sales

Cost (8,000) (8,000) (8,000) (8,000) Cost
Gross Profit 2,000 2,000 2,000 2,000 Gross Profit
Expenses (500) (500) (500) (500) Expenses
PBIT 1,500 1,500 1,500 1,500 PBIT
Interest (1,000@10%) (100) (100) (100) (100) Interest (1,000@10%)
PBT 1,400 1,400 1,400 1,400 PBT
Tax @ 30% (420) (420) (420) (420) Tax @ 30%
PAT 980 980 980 980 PAT

Dividend distribute (980) (980) (980) (980) Dividend -- 60%

Retain --- 40%
Capital structure 100,000 100,000 100,000 100,000 Capital structure

For expansion --- companies prefer to retain some or entire amount of profits.

How the MV or Ke is calculated when the dividend is growing?

Case 1: When the company retains a fixed % of profit

2018 2019 2020 2021 MV = Do x (1+g) / (Ke - g)

Opening Equity 100,000 104,000 108,160 112,486 Do Latest dividend that the
g Growth rate -- by which
Return on equity @ 10% 10,000 10,400 10,816 11,249 Ke Cost of equity
Dividend @ 60% (6,000) (6,240) (6,490) (6,749)
Profits retained 4,000 4,160 4,326 4,499 There are two methods to calculat

Closing equity 104,000 108,160 112,486 116,986 Case 1: When the company retains
Dividend 6,000 6,240 6,490 6,749 g=bxr Gordon's growth model
Growth 4% 4% 4%
r = return on equity
b 40% b = retention %
r 10%
g 4%

MV = Do x (1+g) / (Ke - g)
MV = 9 x (1 + 6.48%) / (14% - 6.48%)
MV = 127.44

The MV per share of the Company is Rs 127.44

g = (Latest div/Oldest Div)^(1/t) - 1

g = (9 / 7)^(1/4) - 1
Latest div 9 g = 6.48%
Ref div 7
Time (years) 4
Ke 14%
MV ?

Ke = [Do (1 + g)/MV] + g

Ke = [45 x (1 + 12.47%)/366] + 12.47%

Ke = 26.3%
 2018

10,000 MV = Do x (1+g) / (Ke - g)

(8,000)
2,000 Do Latest dividend that the Company has paid.
(500) g Growth rate -- by which dividend is growing
1,500 Ke Cost of equity
1,000@10%) (100)
1,400 Dividend can grow when the Company retains some amount of profit.
(420)
980

588
392
100,392

Div
Year 1 40.00 FV = PV ( 1 + g )^n
x (1+g) / (Ke - g) Year 2 42.00 50 = 40 [(1+g)^(4)]
Year 3 47.00 50 / 40 = (1+g)^4
Latest dividend that the Company has paid. Year 4 47.00 (50/40)^(1/4) = (1 + g)
Growth rate -- by which dividend is growing Year 5 50.00 (50 / 40)^(1/4) - 1 = g
Cost of equity
Growth (50/40)^(1/4) - 1 5.74% g = (Latest Div/Oldest div)^(1
two methods to calculate growth:

hen the company retains a fixed % of profit Case 2: When the dividend is different every year.
 Gordon's growth model CAGR = (Latest Div/Oldest div)^(1/t) - 1

Cumulative annual growth rate (CAGR)

Div / Ke
/ (14% - 6.48%) Div (1+g) / Ke - g

the Company is Rs 127.44.

t Div)^(1/t) - 1

%)/366] + 12.47% g = (Latest div/Ref div)^(1/time) - 1

g = (45/25)^(1/5) - 1
g = 12.47%

g = (62/55)^(1/3) - 1
g = 4.07%

MV = Do x (1 + g)/(Ke - g) OR
MV = 62 x (1 + 4.07%) / (8% - 4.07%) MV = D1 / (Ke - g)
MV = 1,642 Ke = [D1 / MV] + g
Ke = [Do x (1 + g)/MV] + g
Ke = [D1 /MV] + g

g = (37/28)^(1/3) - 1
g = 9.74%

Ke = [37 x (1+9.74%) / 470] + 9.74%

Ke = 18.38%
FV = PV ( 1 + g )^n
50 = 40 [(1+g)^(4)]
50 / 40 = (1+g)^4
(50/40)^(1/4) = (1 + g)
(50 / 40)^(1/4) - 1 = g

g = (Latest Div/Oldest div)^(1/t) - 1

Debt can be of two types: Case 1: Irredeemable debt.

1: Irredeemable debt --- unlimited term/time period. MV = Sum of PV of interest

2: Redeemable debt --- limited term/time period.
MV of irredeemable debt = Interest /
Coupon rate is applied on face value = Interest amount Kd = Interest / MV of redeemable deb
Face value = nominal value of the bond/debenture etc.
Term - time period for which the bond is issued. Interest = Coupon rate x face value of
Redemption value -- amount at which the bond shall be redeemed.
Market value -- at which the bond shall be traded. Kd:
Pre-tax Kd
The rate required by the lender (Kd) Post-tax Kd
Rate offered by similar securities in the market. Post-tax Kd = Pre-tax Kd x (1 - t)

MV of debt --- How to calculate? Face value is Rs 1,000 and interest rat
Pre-tax Kd is 8%.
Kd --- How to calculate? Calculate MV

MV = (1,000 x 7%) / 8%
MV = 70 / 8%
MV = 875

Interest = 500 x 8.5%

Interest = 42.5

MV = 42.5 / 8.04%
MV = 528.6
 redeemable debt.

m of PV of interest

edeemable debt = Interest / Kd

est / MV of redeemable debt

Coupon rate x face value of debt

MV = Pre-tax interest / Pre-tax Kd

MV = Post-tax interest / Post-tax Kd
d = Pre-tax Kd x (1 - t)
Face value is Rs 1,000 and interest rate is 7%.
e is Rs 1,000 and interest rate is 7%. Pre-tax Kd is 8%.
Calculate MV
Tax rate is 30% Post-tax Kd = 8% x (1 - 30%) = 5.6%

00 x 7%) / 8% MV = [1,000 x 7% x (1-30%)] / 5.6%

MV = 49 / 5.6%
MV = 875

Interest = 500 x 8.5%

Interest = 42.5
Post-tax interest = 42.5 x (1 - 30%)
Post-tax interest = 29.75

MV = 29.75 / 5.63%
MV = 528.4
MV = Interest / Kd
Kd = Interest / MV
Kd = 7 / 108.93
Kd = 6.43%

Kd = Post tax Interest / MV

Kd = 4.9 / 108.93
Kd = 4.5%

Post tax Kd = Pre-tax Kd x (1 - 0.3)

Post tax Kd = 4.5%

Nominal value 500,000,000

Interest @ 8.5% 42,500,000
Market value (500 Mn/100x105.72) 528,600,000
Pre-tax Kd 8.04%

Nominal value 500,000,000

Interest @ 8.5% 42,500,000
Interest @ 8.5% - Post tax 29,750,000
Market value (500 Mn/100x105.72) 528,600,000
Post tax Kd (Post tax Int/MV) 5.63%
2: Redeemable debt --- limited term/time period. Particulars Year 0

Term (years) 5 Interest -

Face value 1,010 Redemption -
Coupon rate 8% Net CF -
Redemption value 1,000 PV @ 9% -
Lender's required rate of return (Pre-tax MV 968
Kd) 9%
MV ? You can not multiply pre-tax Kd with (1-t) and ge

Tax Rate 30% Particulars Year 0

Market value (968)
Interest (Post tax) -
Redemption -
Net CF (968)
PV @ 10% (968)
PV @ 10% (128)
PV @ 5% (968)
PV @ 5% 66
Post tax Kd (IRR) 6.7%
Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Market value (104.50) - - - - -
Interest - 7.00 7.00 7.00 7.00 7.00
Redemption - - - - - -
Net CF (104.50) 7.00 7.00 7.00 7.00 7.00
PV @ 10% (104.50) 6.36 5.79 5.26 4.78 4.35
PV @ 10% (14.74)
PV @ 5% (104.50) 6.67 6.35 6.05 5.76 5.48
PV @ 5% 9.38
Pre-tax Kd (IRR) 6.77%

Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Market value (104.50) - - - - -
Interest - 4.90 4.90 4.90 4.90 4.90
Redemption - - - - - -
Net CF (104.50) 4.90 4.90 4.90 4.90 4.90
PV @ 3% (104.50) 4.76 4.62 4.48 4.35 4.23
PV @ 3% 9.98
PV @ 5% (104.50) 4.67 4.44 4.23 4.03 3.84
PV @ 5% (1.28)
Post-tax Kd (IRR) 4.76%

Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Interest - 7.00 7.00 7.00 7.00 7.00 7.00
Redemption - - - - - - -
Net CF - 7.00 7.00 7.00 7.00 7.00 7.00
PV @ 6.8% - 6.55 6.14 5.75 5.38 5.04 4.72
MV 99.82

Particulars Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

Market value (99.82)
Interest - 4.90 4.90 4.90 4.90 4.90 4.90
Redemption - - - - - - -
Net CF (99.82) 4.90 4.90 4.90 4.90 4.90 4.90
PV @8% (99.82) 4.54 4.20 3.89 3.60 3.33 3.09
PV @8% (17.13)
PV @4% (99.82) 4.71 4.53 4.36 4.19 4.03 3.87
PV @4% 4.06
Post tax Kd (IRR) 4.68%
 Year 1 Year 2 Year 3 Year 4 Year 5

80 80 80 80 80
- - - - 1,010
80 80 80 80 1,090
73 67 62 57 708

y pre-tax Kd with (1-t) and get post-tax Kd REDEEMABLE DEBT

Year 1 Year 2 Year 3 Year 4 Year 5

- - - - -
56 56 56 56 56
- - - - 1,010 IRR = 5% + 66/[66 - (-128)] x (10% - 5%)
56 56 56 56 1,066 IRR = 6.7%
51 46 42 38 662
= 9% x (1 - 0.3)
53 51 48 46 835 = 6.3%

Particulars Year 0 Year 1 Year 2 Year 3 Year 4

Interest - 7.00 7.00 7.00 7.00
Redemption - - - - 100.00
Net CF - 7.00 7.00 7.00 107.00
PV @ 8.14% - 6.47 5.99 5.54 78.24
MV 96.24

Particulars Year 0 Year 1 Year 2 Year 3 Year 4

Market value (96.24)
Interest - 4.90 4.90 4.90 4.90
Redemption - - - - 100.00
Net CF (96.24) 4.90 4.90 4.90 104.90
PV @8% (96.24) 4.54 4.20 3.89 77.10
PV @8% (6.50)
PV @4% (96) 4.71 4.53 4.36 89.67
PV @4% 7.03
Post tax Kd (IRR) 6.00%

Particulars Year 0 Year 1 Year 2 Year 3 Year 4

Interest - 7.00 7.00 7.00 7.00
Redemption - - - - 108.00
 Net CF - 7.00 7.00 7.00 115.00
PV @ 8.14% - 6.47 5.99 5.54 84.09
MV 102.09

Particulars Year 0 Year 1 Year 2 Year 3 Year 4

Market value (102.09)
Interest - 4.90 4.90 4.90 4.90
Redemption - - - - 108.00
Net CF (102.09) 4.90 4.90 4.90 112.90
PV @8% (102.09) 4.54 4.20 3.89 82.98
PV @8% (6.47)
PV @4% (102) 4.71 4.53 4.36 96.51
PV @4% 8.02
Post tax Kd (IRR) 6.12%

Year 6
-
7.00
105.00
112.00
63.22

83.58

Year 6
-
4.90
105.00
109.90
92.04

82.01

Year 7
7.00
98.00
105.00
66.25

Year 7

4.90
98.00
102.90
60.04

78.20
-128)] x (10% - 5%)
 Equity

Market value of equity (15,000 / 10 x 16.10) 24,150

Cost of equity [Do x (1+g)/MV + g]

Latest dividend 1.90

Reference/Oldest dividend 1.70
s Time 3.00
Growth (1.9/1.7)^(1/3) - 1 3.78%

Cost of equity [1.9 x (1+3.78%)/16.10 + 3.78%] 16.02%

Preference shares
Market value of pref shares (6,000/10 x 8.64) 5,184
Kp (Pref div / MV = 0.6 / 8.64) 6.94%

Bank Loan
Market value of bank loan 5,000
Post tax cost of bank loan [5.5% x (1-0.3)] 3.85%

MV of bonds Year 0 Year 1 Year 2 Year 3

Interest - 640 640 640
Redemption - - - -
Net Cash Flows - 640 640 640
PV @ 9.10% - 587 538 493
MV 8,176

Post tax Kd Year 0 Year 1 Year 2 Year 3

Market value (8,176) - - -
Interest - 448 448 448
Redemption - - - -
Net Cash Flows (8,176) 448 448 448
PV @ 10% (8,176) 407 370 337
PV @ 10% (1,014)
PV @ 5% (8,176) 427 406 387
PV @ 5% 658
Post tax Kd 6.97%

A% + [NPVa / (NPVa - NPVb)] x (B% - A%)

WACC MV Cost % Cost

Ordinary shares 24,150 16.02% 3,869.82

Pref shares 5,184 6.94% 360.00
Long term bonds 8,176 6.97% 569.78
Bank Loan 5,000 3.85% 192.50
42,510 4,992

WACC (4,992/42,510) 11.74%

Equity
Market value (230,000 / 10 x 14.26) 327,980
Cost of equity [2.25 x (1+4%)/14.26] + 4% 20.41%

Preference shares
Market value (50,000 / 10 x 10.56) 52,800
Cost of pref shares (0.5/10.56) 4.73%

Bank Loan
Market value 30,000
Post tax cost of bank loan 4.90%

Long term bonds Year 0 Year 1 Year 2 Year 3

Market value (104,995) - - -
Interest - 4,620 4,620 4,620
Redemption - - - -
Net Cash Flows (104,995) 4,620 4,620 4,620
PV @ 10% (104,995) 4,200 3,818 3,471
PV @ 10% (15,219)

PV @ 5% (104,995) 4,400 4,190 3,991

PV @ 5% 1,885

Post tax Kd (IRR) 5.55%

A% + [NPVa / (NPVa - NPVb)] x (B% - A%)

WACC MV Cost % Cost

Ordinary shares 327,980 20.41% 66,939

Pref shares 52,800 4.73% 2,500
Long term bonds 104,995 5.55% 5,828
Bank Loan 30,000 4.90% 1,470
515,775 76,737
WACC (76,737/515,775) 14.88%
Year 4 Year 5
640 640
- 8,800
640 9,440
452 6,107

Year 4 Year 5
- -
448 448
- 8,800
448 9,248
306 5,742

369 7,246
Year 4
-
4,620
110,000
114,620
78,287

94,298
100 basis is points is equal to 1%.
150 basis is points is equal to 1.5%.

MV Year 0 Year 1 Year 2 Year 3 Year 4

Sales - 12,500 25,700 68,900 45,300
Cost - (5,000) (10,000) (25,000) (17,500)
Depreciation - (5,000) (5,000) (5,000) (5,000)
- 2,500 10,700 38,900 22,800
Tax @ 30% - (750) (3,210) (11,670) (6,840)
Depreciation - 5,000 5,000 5,000 5,000
Initial outlay (20,000) - - - -
Net Cash Flows (20,000) 6,750 12,490 32,230 20,960
PV @ 29.42% (20,000) 5,216 7,457 14,868 7,471
NPV 15,012

Since it is positive, we should take up the project.

Existing WACC

MV of equity (230,000/10 x 14.26) 327,980

Growth 4.00%
Latest dividend (Do) 2.25

Ke - [Do x (1+g)/MV] + g 20.41%

MV of preference shares (50,000/10 x 10.56) 52,800

Kp (0.5 / 10.56) 4.73%

Bank loan 30,000

Post tax Kb [7% x (1-30%)] 4.90%

MV of 6% long term bonds (110,000/100 x 95.45) 104,995

Particulars Year 0 Year 1 Year 2 Year 3 Year 4

MV (104,995) - - - -
Interest @ 6% post tax - 4,620 4,620 4,620 4,620
Redemption - - - - 110,000
(104,995) 4,620 4,620 4,620 114,620
Post tax Kd (IRR) 5.50%

Existing WACC MV Cost% Cost

Ordinary shares 327,980 20.41% 66,939
Preference shares 52,800 4.73% 2,500
Long terms bonds 104,995 5.50% 5,773
Bank loan 30,000 4.90% 1,470
515,775 76,682
Existing WACC 14.87%

New WACC MV Cost% Cost

Ordinary shares 327,980 21.91% 71,859
Preference shares 52,800 4.73% 2,500
Long terms bonds 6% 104,995 5.50% 5,773
Bank loan 30,000 4.90% 1,470
Long terms bonds 8% 20,735 5.69% 1,181
536,510 82,782

New WACC 15.43%

Kd of new debt
MV Year 0 Year 1 Year 2 Year 3 Year 4
Interest @8% - 1,600 1,600 1,600 1,600
Redemption - - - - 21,000
Net cash flows - 1,600 1,600 1,600 22,600
PV @ 8% - 1,481 1,372 1,270 16,612
MV 20,735

Post tax Kd Year 0 Year 1 Year 2 Year 3 Year 4

MV (20,735) - - - -
Interest @8% - 1,120 1,120 1,120 1,120
Redemption - - - - 21,000
Net cash flows (20,735) 1,120 1,120 1,120 22,120
Post tax Kd (IRR) 5.69%

MCC New Old Change

Return 82,782 76,682 6,101
Capital structure 536,510 515,775 20,735

MCC (6,101/20,000) 29.42%

 Book value (Nominal value)
Interest coupon rate
Pre-tax Kd

Interest amount
Tax rate
Tax benefit (640 x 30%)

PV of tax shield (192,000/10%)

Market value of debt x tax rate = PV of tax shield
D x t = PV of TS Formula: D x t (6,400,000 x 30%

Market value of debt = Interest

MV of debt = 640,000/10%
MV of debt = 6,400,000

Book value (Nominal value)

Interest coupon rate
Pre-tax Kd

Interest amount
Tax rate
Tax benefit (1,150 x 30%)
PV of tax shield (345,000/12.5

Formula: D x t (9,200,000 x 30%

Market value of debt = Interest

MV of debt = 1,150,000/12.5%
MV of debt = 9,200,000

=Dxt
= 9,000,000 x 30%
= 2,700,000
Debt 500,000 Post tax Kd 7.00% 35,000
Equity 583,333 Ke 18.00% 105,000
1,083,333 140,000
WACC (140,000 / 1,083,333) 12.92%

WACCg = 15% x [1 - {(500,000x30%)/1,083,333}

 WACCg = 12.92%
WACC of the geared/levered company.

Equity 4,000,000 Cost of equity 20% 800,000

Debt 1,200,000 Kd (8% x 0.7) 5.6% 67,200
Co MV 5,200,000 867,200

WACC (867,200 / 5,200,000) 16.68%

All equity MV: All equity company - MV 940,000

MVg = MVu + (D x t) Debt (200 + 100) 300,000

1,000,000 = MVu + (200,000 x 30%) Equity component 640,000
MVu = 1,000,000 - 60,000 D x t (300 x 30%) 90,000
MVu = 940,000 Equity MV 730,000
Co MV 1,030,000
All equity Ke
10% = Keu + {D(1-t)/E} x (Keu - Kd) OR
10% = Keu + {200,000 x 0.7/800,000} x (Keu - 7.5%) MVg = MVu + (D x t)
10% = Keu + 0.175 x (Keu - 7.5%) MVg = 940,000 + (300,000 x 0.3)
10% = Keu + 0.175Keu - 1.3125% MVg= 1,030,000
10% + 1.3125% = 1.175Keu
11.3125% / 1.175 = Keu
Keu = 9.63%
Keu of an ungeared company = 9.63%
 ook value (Nominal value) 8,000,000 PV of Perpetuity Cash Flows R/i
nterest coupon rate 8%
10% Constant cash flow = tax benefit = 345,000
Discount rate = I = Pre tax Kd = 12.5%
nterest amount 640,000
30.00%
ax benefit (640 x 30%) 192,000

V of tax shield (192,000/10%) 1,920,000

ormula: D x t (6,400,000 x 30%) 1,920,000

Market value of debt = Interest / Kd

MV of debt = 640,000/10%
MV of debt = 6,400,000

ook value (Nominal value) 11,500,000

nterest coupon rate 10%
12.50%

nterest amount 1,150,000

30.00%
ax benefit (1,150 x 30%) 345,000
V of tax shield (345,000/12.5%) 2,760,000

ormula: D x t (9,200,000 x 30%) 2,760,000

Market value of debt = Interest / Kd

MV of debt = 1,150,000/12.5%
MV of debt = 9,200,000

9,000,000 x 30%

Equity 7,000,000

MM theory without taxes: MVg = Mvu

Equity 4,500,000
Debt 2,500,000
MV 7,000,000
MM theory with taxes: MVg = MVu + (D x t)

Equity 4,500,000
Debt 2,500,000
7,000,000
Dxt 750,000
MV 7,750,000

Equity 4,000,000

MM theory without taxes: MVg = Mvu

Equity 3,000,000
Debt 1,000,000
MV 4,000,000

MM theory with taxes: MVg = MVu + (D x t)

Equity 3,000,000
Debt 1,000,000
4,000,000
Dxt 300,000
MV 4,300,000

All equity company Keg = Keu + [D(1-t)/E] x (Keu - Kd)

Keg = 15% + [500,000 x (1 - 30%) / 583,333] x (15% - 1
MV ? Keg = 18%
PBIT 200,000
Tax rate 30.00% Another method of calculating Ke of a geared compan

WACC = PBIT (1 - t) / MV PBIT 200,000

MV = PBIT (1 - t)/ WACC Interest @ 10% (50,000)
MV = 200,000 (1 - 30%) / 15% PBT 150,000
MV = 933,333 ----- (a) Tax @ 30% (45,000)
PAT (Dividend) 105,000
Equity 933,333 Before issuance of debt

Ke = Div / MV
Debt 500,000 Issuance of debt Ke = 105,000 / 583,333
Equity 433,333 Ke = 18% ---- (b)
Dxt 150,000
Equity MV 583,333
 Co. MV 1,083,333

MV of ungeared company:
MVg = (MVu + D x t)
5,200,000 = MVu + (1,200,000 x 0.3)
MVu = 5,200,000 - (1,200,000 x 0.3)
MVu = 4,840,000

20% = Keu + {D(1-t)/E} x (Keu - Kd)

20% = Keu + {1,200,000 x 0.7/4,000,000} x (Keu - 8%)
20% = Keu + 0.21 x (Keu - 8%)
20% = Keu + 0.21Keu - 1.68%
20% + 1.68% = 1.21Keu
21.68% / 1.21 = Keu
Keu = 17.92%
Keu of an ungeared company = 17.92%

Part b)
All equity company - MV 4,840,000

Debt (1,200 + 500) 1,700,000 Keg = Keu + (Keu - Kd) x D(1-t)/E

Equity component 3,140,000 Keg = 17.92% + (17.92% - 8%) x 1,700,000 (1 - 30%)/3,650,000
D x t (1,700 x 30%) 510,000 Keg = 21.15%
Equity MV 3,650,000
Co MV 5,350,000 Equity 3,650,000 21.15% 771,975
Debt 1,700,000 5.60% 95,200
OR 5,350,000 867,175
MVg = MVu + (D x t)
MVg = 4,840,000 + (1,700,000 x 0.3) WACC (867,175 / 5,350,000) 16.21%
MVg= 5,350,000

WACCg = 17.92% x {1 - (1,700,000 x 30%/5,350,000)

WACCg = 16.21%

Part c)
All equity company - MV 4,840,000 Keg = Keu + (Keu - Kd) x D(1-t)/E
Keg = 17.92% + (17.92% - 8%) x 700,000 (1 - 30%)/4,350,000
Debt (1,200 - 500) 700,000 Keg = 19.04%
Equity component 4,140,000
D x t (700 x 30%) 210,000 Equity 4,350,000 19.04% 828,240
Equity MV 4,350,000 Debt 700,000 5.60% 39,200
Co MV 5,050,000 5,050,000 867,440

OR WACC (827,456 / 4,840,000) 17.18%

MVg = MVu + (D x t)
MVg = 4,840,000 + (700,000 x 0.3) WACCg = 17.92% x {1 - (700,000 x 30%/5,050,000)
MVg= 5,050,000 WACCg = 17.18%

Keg = Keu + (Keu - Kd) x D(1-t)/E

Keg = 9.63% + (9.63% - 7.5%%) x 300,000 (1 - 30%)/730,000
Keg = 10.24%

Equity 730,000 10.24% 74,752

Debt 300,000 5.25% 15,750
1,030,000 90,502

WACC (90,502 / 1,030,000) 8.79%

WACCg = 9.63% x {1 - (300,000 x 30%/1,030,000)

WACCg = 8.79%
30%) / 583,333] x (15% - 10%)

ng Ke of a geared company
0%)/3,650,000

%)/4,350,000
For the calculation of WACC MV Cost% Cost
Ordinary Shares 4,302 10.81% 465.05
Term Finance Certificates 936 6.60% 61.78
Non redeemable debentures 563 8.75% 49.28
5,801 576.10
WACC (576.10/5,801) 9.93%

Market values:
Ordinary shares - Cum dividend 18.40
Latest dividend (114/240) (0.475)
Ordinary share - exdividend 17.92
No shares - in Mn 240
Ordinary share - exdividend MV 4,302

TFC's - exinterest 97.50

No of TFCs (960/100) 9.60
TFC's - exinterest MV 936.00

Non-redeemable deb. Cum-interest 99.00

Latest interest (11% x 100) (11.00)
Non-redeemable deb. ex-interest 88.00
No of debentures (640/100) 6.40
Non-redeemable deb. ex-interest MV 563.20

Calculation of Cost of Equity (Ke) Calculation of growth

Ke = [Do x (1 + g)/MV] + g Dividend for the year 2014 (114/240) 0.475
Ke = [0.475 x (1+ 7.95%)/17.93] + 7.95% Dividend for the year 2013 (10x4.4%) 0.440
Ke = 10.81% Growth (0.475/0.44) - 1 7.95%

Post tax Kd - TFC's Year 0 Year 1 Year 2 Year 3 Year 4

Market value (97.50) - - - -
Interest (Post tax) - 100 x 8% x ( 1 - 30%) - 5.60 5.60 5.60 5.60
Redemption amount - - - - 101.00
Net cash flows (97.50) 5.60 5.60 5.60 106.60
Post tax Kd (IRR) 6.6%

Post tax Kd - Debentures

Post tax Kd = Post tax interest / MV

Post tax Kd = 11 x (1 - 30%) / 88
Post tax Kd = 8.75%
WACC as at June 30, 2017 10.98%
WACC as at June 30, 2018 12.68%
Change in GSI's WACC 1.7%

WACC as at June 30, 2017 MV Cost% Cost

Equity - ordinary shares 4,190.40 12.25% 513.32
Debt - 11% debentures 1,034.68 5.9% 60.63
5,225.08 573.96
WACC (573.96/5,225.08) 10.98%

Equity Book Value (2,500 + 992) 3,492.00

P/B ratio 1.20
Equity - MV 4,190.40

Existing cost of equity - Ke Calculation of growth

Ke = {Do x (1+g)/MV} + g Div for 2017 298.00
Ke = {298 x (1 + 4.8%)/4,190.4} + 4.8% Div for 2013 247.00
Ke = 12.25% Time (years) 4.00
G (298/247)^(1/4)-1 4.80%

MV of debentures 2018 2019 2020 2021 2022

Interest 105.60 105.60 105.60 105.60 105.60
Redemption - - - - 960.00
Net cash flows 105.60 105.60 105.60 105.60 1,065.60
PV @ 9% 96.88 88.88 81.54 74.81 692.57
MV 1,034.68

Post tax Kd 2017 2018 2019 2020 2021 2022

MV (1,034.68)
Interest - Post tax - 73.92 73.92 73.92 73.92 73.92
Redemption - - - - - 960.00
Net cash flows (1,034.68) 73.92 73.92 73.92 73.92 1,033.92
Post tax Kd (IRR) 5.9%

WACC as at June 30, 2018 MV Cost% Cost

Equity - ordinary shares 2,949.14 15.90% 468.91
Debt - 11% debentures 1,090.07 3.97% 43.28
4,039.21 512.19
New WACC (512.19/4,039.21) 12.68%

Equity BV as at June 30, 2018 4,213.05

P/B ratio 0.70
Equity - MV as at June 30, 2018 2,949.14

Equity BV as at June 30, 2018 Profit growth

Equity as at June 30, 2017 3,492.00 Profit - 2017
Expected profit [1,752.72x(1+profit growth)]x(1-t) 1,386.40 Profit - 2013
Loss of investments [1,310 x 35% x 1.1 x (1-30%)] (353.04) Time (years)
Dividend for 2018 {298 x (1 + 4.8%)} (312.30) Growth
Equity BV as at June 30, 2018 - estimated 4,213.05

Revised cost of equity - Ke

Ke = {Do x (1+g)/MV} + g
Ke = {312.3 x (1 + 4.8%)/2,949.14} + 4.8%
Ke = 15.9%

MV of debentures 2019 2020 2021 2022

Interest 105.60 105.60 105.60 105.60
Redemption - - - 960.00
Net cash flows 105.60 105.60 105.60 1,065.60
PV @ 7% 98.69 92.24 86.20 812.94
MV 1,090.07

Post tax Kd 2018 2019 2020 2021 2022

MV (1,090.07) - - - -
Interest - Post tax - 73.92 73.92 73.92 73.92
Redemption - - - - 960.00
Net cash flows (1,090.07) 73.92 73.92 73.92 1,033.92
Post tax Kd (IRR) 3.97%
1,752.72
1,075.00
4.00
13.00%
Equity - MV (Price) 7,346.59 Profit after tax 1,166.12 70%
P/E multiple 6.30 Tax (1,166.12 / 70 x 30) 499.77 30%
Earnings (profit after tax) 1,166.12 Profit before tax 1,665.89
Interest - old debt 700.00
Interest - new debt 181.34
P/E multiple = Price/ Earnings PBIT 2,547.24
Earnings = Price / PE Multiple Exisiting PBIT 2,150.00
Increase in PBIT 397.24
Existing MV of equity 6,090.00
Existing MV of debt 5,567.60
Total existing MV 11,657.60
New investment to be made 2,500.00
Post investment MV 14,157.60

Existing MV of equity
Profit before interest and tax 2,150.00
Interest on TFC's (5,000 x 14%) (700.00)
Profit before tax 1,450.00
Tax @ 30% (435.00)
Profit after tax 1,015.00
P/E Multiple 6.00
MV - Equity 6,090.00

Existing MV of debt Year 1 Year 2

Interest (5,000 x 14%) 700.00 700.00
Redemption (10% premium) 5,500.00
700.00 6,200.00
PV @ 12% 625.00 4,942.60
MV 5,567.60

D/E Ratio Post Inv Existing Issue

Equity 50.00% 7,078.80 6,090.00 988.80
Debt 50.00% 7,078.80 5,567.60 1,511.20
14,157.60 11,657.60

b) Change in earnings

Existing MV of debt Year 1

Interest (5,000 x 14%) 700.00
Redemption (10% premium) 5,500.00
6,200.00
PV @ 10% 5,636.36
Old debt - MV 5,636.36

New MV of debt Year 1 Year 2 Year 3 Year 4

Interest (1,511.20 x 12%) 181.34 181.34 181.34 181.34
Redemption (10% premium) 1,662.32
181.34 181.34 181.34 1,843.66
PV @ 10% 164.86 149.87 136.25 1,259.25
New debt - MV 1,710.22

Old debt - MV 5,636.36

New debt - MV 1,710.22
Total debt - MV 7,346.59
Since the D/E ratio is 50:50, hence the equity MV should also be 7,346.59
 MV K
Ordinary shares 37,600 12.15% 4,568
Preference shares 1,200 10.00% 120
Bonds 3,135 4.76% 149
Bank Loan 1,000 4.76% 48 In line with the market rate of bonds
42,935 4,885 Variable rate is always in line with the market.

WACC (4,885 / 42,935) 11.4%

Ordinary shares Ke
No of ordinary shares (4,000 / 0.5) 8,000 Do (latest dividend)
MV per share 4.70 MV per share
MV of ordinary shares 37,600 Growth
Ke [Do x (1+g)/MV + g]
Preference shares
No of preference shares (3,000/1) 3,000 Growth
MV per pref share 0.40 Latest div
MV of preference shares 1,200 Oldest div
Time
Cost of pref shares -- Kp Growth (lat/old)^(1/t)-1
Div (1 x 4%) 0.04
MV 0.40
Kp (0.04 / 0.4) 10%

Bonds
No of bonds (3,000 / 100) 30.00
MV per bond 104.50
MV of bonds 3,135

Post tax Kd 0 1 2 3 4 5

MV (104.50) - - - - -
Post tax interest - 4.90 4.90 4.90 4.90 4.90
Redemption - - - - - -
Net Cash Flows (104.50) 4.90 4.90 4.90 4.90 4.90

Post tax Kd (IRR) 4.76%

Post tax interest: 100 x 7% x (1 - 30%) 4.90

et rate of bonds
ys in line with the market.

0.363
4.70
4.11%
1+g)/MV + g] 12.15%

0.363
0.309
4.00
at/old)^(1/t)-1 4.11%

-
4.90
105.00
109.90
Cum dividend price 7.52 this includes the impact of latest dividend
Ex dividend price 7.07 this does not include the impact of latest dividend
Latest dividend 0.45 for the year 20X7

MV K
Ordinary shares 169.68 11.70% 19.85
Preference shares 3.10 8.06% 0.25
Bonds 10.23 5.39% 0.55
Bank Loan 3.00 5.39% 0.16 In line with the market rate of bonds
186 21 Variable rate is always in line with the market.

WACC (21/186) 11.2%

Ordinary shares Ke
No of ordinary shares (12 / 0.5) 24 Do (latest dividend)
MV per share 7.07 MV per share
MV of ordinary shares 169.68 Growth
Ke [Do x (1+g)/MV + g]
Preference shares
No of preference shares (5/0.5) 10 Growth
MV per pref share 0.31 Latest div
MV of preference shares 3.10 Oldest div
Time
Cost of pref shares -- Kp Growth (lat/old)^(1/t)-1
Div (0.5 x 5%) 0.03
MV 0.31
Kp (0.04 / 0.31) 8.06%

Bonds
No of bonds (10 / 100) 0.1
MV per bond 102.34
MV of bonds 10.23

Post tax Kd 0 1 2 3 4

MV (102.34) - - - -
Post tax interest - 4.90 4.90 4.90 4.90
Redemption - - - - 105.00
Net Cash Flows (102.34) 4.90 4.90 4.90 109.90

Post tax Kd (IRR) 5.39%

Post tax interest: 100 x 7% x (1 - 30%) 4.90

et rate of bonds
ys in line with the market.

0.450
7.07
5.02%
1+g)/MV + g] 11.70%

0.450
0.370
4.00
at/old)^(1/t)-1 5.02%
 MV K
Ordinary shares 391,920 10.10% 39,596.80
Preference shares 2,800.00 8.93% 250.00
Bonds 10,499.50 5.57% 584.56
Bank Loan 3,000.00 5.25% 157.50 In line with the market rate of bonds
408,220 40,589 Variable rate is always in line with the marke

WACC (40,589/408,220) 9.9%

Ordinary shares Ke
No of ordinary shares (23,000/ 0.25) 92,000 Do (latest dividend)
MV per share 4.26 MV per share
MV of ordinary shares 391,920 Growth
Ke [Do x (1+g)/MV + g]
Preference shares
No of preference shares (5,000/1) 5,000
MV per pref share 0.56
MV of preference shares 2,800.00

Cost of pref shares -- Kp

Div (1 x 5%) 0.05
MV 0.56
Kp (0.05/0.56) 8.93%

Bonds
No of bonds (11,000 / 100) 110.00
MV per bond 95.45
MV of bonds 10,499.50

Post tax Kd 0 1 2 3 4 5

MV (95.45) - - - - -
Post tax interest - 4.50 4.50 4.50 4.50 4.50
Redemption - - - - - 100.00
Net Cash Flows (95.45) 4.50 4.50 4.50 4.50 104.50

Post tax Kd (IRR) 5.57%

Post tax interest: 100 x 6% x (1 - 25%) 4.50

et rate of bonds
ys in line with the market.

0.250
4.26
4.00%
1+g)/MV + g] 10.10%