Weighted Average Cost of Capital
Question 1
The following information is available on the long term financing of Sigma plc:
£m
Ordinary shares of £1 each (15 million) 15
7% irredeemable debentures 28
The current share price is 290p and the market value of debentures is £93 (per £100 nominal).
A dividend of 12 pence per share has just been paid. The expected growth rate of dividends is 6%.
The corporation tax rate 25%
a) Calculate the weighted average cost of capital (WACC) for Sigma plc.
I'm still quite unclear on how to calculate cost of debt. Please provide a full detail methods of calculation
Weighted Average Cost of Capital
Question 1
The following information is available on the long term financing of Sigma plc:
£m
Ordinary shares of £1 each (15 million) 15
7% irredeemable debentures 28
The current share price is 290p and the market value of debentures is £93 (per £100 nominal).
A dividend of 12 pence per share has just been paid. The expected growth rate of dividends is 6%.
The corporation tax rate 25%
a) Calculate the weighted average cost of capital (WACC) for Sigma plc.
I'm still quite unclear on how to calculate cost of debt. Please provide a full detail methods of calculation
Related questions
Financial Analysis Exercise IV
Part A: Weighted Average Cost of Capital (WACC)
Here again is the formula for WACC. For simplicity the term for preferred stock has been removed:
Go to http://thatswacc.com/[1] and enter the ticker symbol for the stock you selected and click on the tab entitled âCalculate WACC.â
Complete the following tables:
| Name of Company/Stock | Walt Disney |
| Ticker Symbol | DIS |
From the http://thatswacc.com/ results for your company:
| WACC | 13.50% |
| Cost of debt, iD | 0 |
| Corporate tax rate, TC | 34.98 |
| Total debt, D | 48,768,000 |
| Total equity, E | 10,251,618,400 |
| Total firm value, V | 10,300,386,400 |
| Cost of equity, iE | 13.56% |
CAPM Components
| Beta, β | 1.32 |
| Historical market return, iM | Assumed 11% |
| Risk-free rate, iF | Assumed 3% |
Using data in the table confirm the accuracy of the siteâs WACC calculation:
| Weight of Equity | ||
| Weighted Average Cost of Equity | E | |
| Weight of Debt | ||
| Pre-Tax Weighted Average Cost of Debt | D | |
| After-Tax Weighted Cost of Debt | D · (1- TC) | |
| Weighted Average Cost of Capital | = · iE + · iD · (1-Tc) |
Part B: Dividend Payout and Growth Ratios
Recall from Module 1 the following two ratios:
Internal growth rate = (ROA â RR) / [1-(ROA â RR)] (Eq. 3-30)
where RR = Retention ratio = (Addition to retained earnings)/Net income (Eq. 3-31)
The internal growth rate measures the amount of growth a firm can sustain if it uses only internal financing (retained earnings) to increase assets
Sustainable growth rate = (ROE â RR) / [1-(ROE â RR)] (Eq. 3-33)
If the firm uses retained earnings to support asset growth, the firmâs capital structure will change over time, i.e., the share of equity will increase relative to debt
To maintain the same capital structure managers must use both debt and equity financing to support asset growth
The sustainable growth rate measures the amount of growth a firm can achieve using internal equity and maintaining a constant debt ratio
1. For the firm selected for Part A, calculate its internal growth rate for the last fiscal year:
| = (ROA â RR) / [1-(ROA â RR)] = |
2. Calculate the firmâs sustainable growth rate for the last fiscal year:
| = (ROE â RR) / [1-(ROE â RR)] = |
Part C.
Consider your results for Parts A and B. If the chosen firm grows at its internal growth rate, increasing assets only with its retained earnings, how will this likely affect its WACC? Show calculations.
If the chosen firm grows at its sustainable growth rate with increases in both its retained earnings and debt, maintaining a constant debt ratio, how will this affect its WACC?
If the chosen firm attempts to grow faster than its sustainable growth rate with modest increases in its debt ratio, how will this likely affect its WACC? What about very large increases in its debt ratio? Explain.
[1] The accessibility of this site is assumed. Should it not be accessible, please follow the instructions in the Appendix at the end of this document.
