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Calculation Of Weighted Average Cost Of Capital And Evaluate Potential Projects

Question

The following information has been extracted from the 2000 Balance Sheet of Premier Milling Company Ltd

 

$000’s

Paid up capital- 1 million shares

2,000

Retained earnings

500

9% debenture (maturing November 2008)

300

Promissory notes

500

12% Preference capital — 200,000 shares

200

Trade creditors

400

Bank overdraft

300

  • Premier Milling paid a total of $400,000 in dividends this year. It is expected that dividends will grow at 5% per annum, in perpetuity. Ordinary dividends are fully franked.
  • Premier Milling’s market capitalisation is $3,200,000
  • The debentures were issued at par in 1988, giving the company proceeds of $100 each. The current market value of each debenture is $107. Coupons are paid semi-annually. The November 2000 coupon has already been paid.
  • The promissory notes are a permanent source of funds. The notes currently on issue have 45 days to maturity. The current yield on comparable securities is 7% per annum.
  • The preference shares were issued in 1993. They are not actively traded, but it is estimated that a similar issue now would net the company $0.90 after floatation costs. This amount can also be used to determine the current market capitalisation of preference capital. The Preference dividend is not franked.
  • The current bank overdraft rate is 9% per annum, compounded daily. The current level of overdraft is seen as a permanent source of funds.
  • The corporate tax rate is 30%, and it has been estimated that the franking credit utilisation rate is 40%.
  • Current market value of capital is representative of target capital structure.
  • Minimal retained earnings are available for investment. It is estimated that floatation costs for ordinary capital would amount to $0.20 per share.

a) In calculating the weighted average cost of capital, which sources of finance, listed in the above table, would not be included in your calculation, and why?

b) Calculate the weighted average cost of capital (WACC) for Premier Milling Company Ltd.

c) What are the two main assumptions that Premier Milling would be making if they apply the WACC, calculated in b), to evaluate potential projects?

 

Summary

The question belongs to Finance and it discusses about calculation of weighted average cost of capital and evaluating potential projects.

Total Word Count 234

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