Cost of capital Burse Co wishes to calculate the weighted average cost of capital and the following information relates

to the company at the current price : $000 Number of ordinary shares ( 50 cents per share ) Book value of 9% preference share ( per value $1 ) Book value of 10% redeemable debt - 1 Book value of 7% redeemable debt - 2 Book value of 8% bank loan ( Bank term loan ) Book value of 9% irredeemable debenture Book value of 7% convertible debt Additional information : Market price / value of ordinary shares Market price / value of convertible debt $5.50 per share $107.11 per $100 bond 2500 2500 5000 4000 300 600 5500

The convertible debt can be redeemed at par in eight years time, or converted in six years time into 15 shares of Burse Co per $100 bond. The 10% loan notes 1 are redeemable at par in eight years time. They have a current ex interest market price of $100 per $100 loan notes. The 7% bonds-2 are redeemable at par in seven years time. They are trading on an ex interests basis at $94.74 per $100 bond. The irredeemable debenture stock has a market price of $75. The current ex dividend preference share price is 76.2 cents.

Note-1 : To calculate KE Equity beta of Burse Co Risk free rate of return (RF) Market rate of return (RM) Equity risk premium (RM RF) 1.2 4.7% 11.2% 6.5%

Note-2 : To calculate KE The current ex dividend share price is $5.50 per share. An ordinary dividend of 50 cents per share has just been paid. --------- OR ---------The current cum dividend share price (market price) is $6 per share (Quoted at $6 per share). A dividend of 50 cents per share is about to be paid. Dividend growth (A) No growth in dividend (B) Dividends are expected to increase by 4% per year for the foreseeable future. (C) Next ordinary dividend per share, payable in one years time, will be 50 cents per share, growing thereafter at 4% per annum indefinitely. (D) Dividend per share in the five preceding years were as follows : 2007 --------------------------- 35 cents 2008 --------------------------- 37 cents 2009 --------------------------- 38 cents 2010 --------------------------- 45 cents 2011 --------------------------- 50 cents (E) Burse Co is about to pay an ordinary dividend of 50 cents a share. The share price is $600 cents. The accounting rate of return on equity is 12.5% and each year the company pays out 20% of its earnings (Profits after tax) as dividend.

Answer : WACC VE KE = VP KP VD KDnet

-------------------- + -------------------- + --------------------VE + VP + VD VE + VP + VD VE + VP + VD

2750012.5% =

190511.8%

5250 6.37%

37906%

3005.6%

4508.4%

58916%

------------------ + ------------------- + ------------------- + --------------- +--------------- + -------------- + -----------45086 45086 45086 45086 45086 45086 45086

= 10.27% or 10.3%

Note : Cost of equity Using CAPM (Note-1) KE = RF +(RM-RF) = 4.7 + 1.2(11.2-4.7) = 4.7% + 7.8% = 12.5% Or 4.7% + 1.2 6.5% ---------- If (RM-RF) or risk premium = 6.5% = 12.5%

Note-2 (A) No growth in dividend (DVM) KE =D/PO Ex dividend share price KE = 0.5/5.5 = 9.09% Cum share price KE = 0.5/6-0.5 = 0.5/5.5 = 9.09%

(B) Constant 4% growth in dividend (DVM with growth) Ex dividend share price KE =D(1+G)/PO+G Cum share price

KE = O.5(1+0.04)/5.5+0.04 =13.45% or 13.5%

KE = O.5(1+0.04)/6-0.5+0.04= =13.45% or 13.5%

(C) Constant 4% growth in dividend (DVM with growth) Ex dividend share price KE =D1 /PO+G KE = O.5/5.5+0.04 =13.09% or 13.1% (D) Past dividend growth model Dividend growth = (2011 dividend/2007 dividend)1/N - 1 = (50 cents/35 cents)1/4 - 1 = (50 cents/35 cents)0.25 - 1 = 1.093 1 = 9.3% KE = O.5(1+0.04)/6-0.5+0.04= =13.09% or 13.1% Cum share price