MMP321 Lecture Notes - Lecture 7: Capital Structure, Net Present Value, Cash Flow

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31 May 2021
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MMP321 Topic 7 Seminar Solutions
1
Topic 7: Capital Structure
Question 1:
CBP Property Trust has 30 million units on issue, with a unit price of $1.15. Equity
holders require a 12.5% return. The trust also has outstanding debt of $57 million
at an interest rate of 9.2% p.a. Calculate the WACC for CBP Property Trust.
ANSWER:
kd = 9.2%
ke = 12.5%
D = $57 million
E = $1.15 x 30 million = $34.5 million
V = $57m + $34.5m = $91.5 million
D/V = $57m/$91.5m = 0.623
E/V = $34.5m/$91.5m = 0.377
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Question 2:
If CBP Property Trust included another source of capital into their capital
structure, how could this additional source be incorporated into the calculation of
their WACC?
ANSWER:
The formula can be expanded to include any number of sources of finance with
different costs. For example, assume CBP has preference shares on issue, we
would adjust the formula to look like:
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Here, P represents the market value of the preference shares, kp represents the
cost of the preference shares. The value would now be the summation of D + P + E.
Question 3:
Why would we use a property fund’s weighted average cost of capital to assess an
investment opportunity?
ANSWER:
The rationale for discounting property cash flows by the WACC is that a property
earning this rate will be able to cover interest payments and pay the required
return on equity. If the calculated NPV, using the WACC as the discount rate, is
positive the property investment will earn a sufficient return to satisfy the claims
of both debt and equity holders.
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2
MMP321 Topic 7 Seminar Questions
Question 4:
When using the weighted average cost of capital to assess an investment, how do
we account for interest costs in the cash-flows?
ANSWER:
We do not subtract interest costs from the cash flows when using the WACC to
discount the future cash flows of an investment. This is because the interest costs
are captured in the cost of debt in the WACC formula.
Question 5:
How do we accommodate the following costs when deriving the weighted average
cost of capital?
i) An ongoing management fee of 0.6%.
ii) A capital raising has a one-off cost of $600,000 to finance an
investment.
ANSWER:
i) Include the management fee into the WACC rate. See table 13.1
example of how this is done.
ii) A one-off cost can be included in the cash flows. In this case the capital
raising cost would most likely occur in year 0 (an initial outlay cost).
Question 6:
Margot Property Company is listed on the ASX. You have the following information:
Share price: $12.25
Number shares on issue: 50 million
Cost of equity: 11.2%
Outstanding debentures: $1.02 billion, with a yield of 6.3%
Corporate tax rate: 30%
Calculate Margot’s after-tax WACC.
ANSWER:
kd = 6.3%
ke = 11.2%
D = $1.02 billion
E = $12.25 x 50 million = $612.5 million
V = $1.02b + $612.5m = $1,632.5 million
D/V = $1,020m/$1,632.5m = 0.625
E/V = $612.5m/$1,632.5m = 0.375
Tc = 0.3
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Question 7:
A property fund is evaluating a property acquisition. The cost of the property is $65
million (inclusive of buying costs). The fund has forecasted the following cash flows
from the property:
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