Assignment - Weighted Average Cost of Capital

[hinanifaf]

Good day all ,
My question is as follows
V ltd financial report
EBIT R400 000
Tax rate 35%
Value of debt R200 000
Cost of debt 15%
Cost of equity 21%
Num of shares 100 000
All earnings are paid out as dividends and the interest rate on all debt will be 18%.

1. What will be the total market value of the firm's equity?
2. What market price per share?
3. The firm's total market value?
4. The firm's weighted average cost of capital.

If any one out there can assist me in this ,i will really appreciate it.This is due 5 September 2010, please

Many thanks
Flora

[hinanifaf]

<blockquote id="quote"><font size="1" face="Verdana, Arial, Helvetica, san" id="quote">quote<hr height="1" noshade id="quote"><i>Originally posted by hinanifaf</i>
<br />Good day all ,
My question is as follows
V ltd financial report
EBIT R400 000
Tax rate 35%
Value of debt R200 000
Cost of debt 15%
Cost of equity 21%
Num of shares 100 000
All earnings are paid out as dividends and the interest rate on all debt will be 18%.

1. What will be the total market value of the firm's equity?
2. What market price per share?
3. The firm's total market value?
4. The firm's weighted average cost of capital.

If any one out there can assist me in this ,i will really appreciate it.This is due 5 September 2010, please

Many thanks
Flora
<hr height="1" noshade id="quote"></font id="quote"></blockquote id="quote">

I have tried to work this out myself,please any one who can comment on this please do so thanks in advance
EBIT 400000
Less Interest 18% -72000
328000
Less Tax -114800
Net Profit after tax 213200
Num of shares 100000
EPS 2.132

A) Market value 213200 -(213200x21%)
213200 - 44772
168428

B) Market price 168428/100000
1.68

c) Total market value V = E + D
168428 + (200000 -15%)
168428 + (200000 - 30000)
168428 + 170000
338428

Market Value Weigh Cost WACC
D) Equity 168428 0.50 15% 0.07
Debt 170000 0.50 21% 0.11
338428 1.00 0.18

[faisal_desperado]

Dear Flora,

The solution, of all queries, provided by you is incorrect, although some of the logics have correctly been applied.

You have calculated interest on EBIT rather than value of debt, although you applied the correct rate of 18% rather than 15%.

Logically, cost of debt is given i.e. 15%, however, 18% is relevant is this case, since value of debt is given, which means market value of debt, which indicates that book value of debt is higher than market value, so the effective rate of interest will be higher which is already given i.e. 18%. Had it not been given it would have been calculated.

Reply to your queries is given below.

<b>1- Market value of Firm's Equity.</b>
EBIT -------------------400,000
Less Interest----------- 36,000 (200,000*18%)
EBT --------------------364,000
Less Tax----------------127,400
Profit to Equity Holders---236,600
Cost of Equity ------------ 21% (Equity capitalization rate)

Market value of equity ---1,126,667 (Profit/Equity Rate)


<b>2- Market price per share.</b>
The way in which you ascertained market price is correct, however your answer is incorrect due to incorrect figures.
Correct answer should be 11.267 i.e. MV of Equity/ No. Of shares or 1,126,667/100,000.

The following is an alternative technique to arrive at the same answer.

Market price per share = EPS * PE ratio
Where EPS is --- 236,600/100,000 = 2.366 and
PE ratio is ------- 1/Ke ----- 1/21% = 4.762 (since PE is reciprocal of Ke)

Market Value per share is ------2.366*4.762 = 11.267


<b>3- Firm's total market value</b>
Market Value of equity-------1,126,667
Market Value of Debt -------- 200,000

Market value of firm.---------1,326,667

<b>4- Firm's weighted average cost of capital</b>

Weighted Cost of equity ------ 21% * 1,126,667/1,326,667 =17.83%
Weighted Cost of debt -------- 18%*65%(100% - 35%tax)* 200,000/1,326,667 =1.763

Weighted Average cost of capital ---- 19.6%


Let me know if confusion still exists.


Best Regards,

Faisal.

[hinanifaf]

Thank you so much Fysal ,this was a good step by step explanation.
Thx
Flora