i. Calculate the weighted average cost of capital (WACC) for M Co as at 31 December 2018. ii. Briefly advise the directors of M Co on the suitability of using the WACC calculated in (a) above to discount the expected cash flows of the project.

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Asked on August 18, 2026Business/Management

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Accepted Answer · 2026-08-18T19:03:46.964Z

i. Calculate the weighted average cost of capital (WACC) for M Co as at 31 December 2018. Assumption: A corporate tax rate of 30\% is assumed as it is not provided in the question. Step 1: Calculate the Cost of Equity (K_e) The cost of equity is calculated using the Dividend Growth Model (K_e = (D_1)/(P_0) + g). Current market price per share (P_0) = GH¢1.45. Most recent dividend (D_0) = 14.1 cents = GH¢0.141. Calculate the dividend growth rate (g) using the geometric mean from 2014 to 2018: g = (D_2018D_2014)^(1)/(n) - 1 = ((0.141)/(0.110))^(1)/(4) - 1 g = (1.281818)^(1)/(4) - 1 = 1.0639 - 1 = 0.0639 or 6.39\% Next year's dividend (D_1) = D_0 (1+g) = GH¢0.141 × (1 + 0.0639) = GH¢0.141 × 1.0639 = GH¢0.1509. Cost of Equity (K_e): K_e = (GH¢0.1509)/(GH¢1.45) + 0.0639 = 0.104069 + 0.0639 = 0.167969 or 16.80\% Step 2: Calculate the Market Value of Equity (V_e) Number of shares = 3 million. Market price per share = GH¢1.45. V_e = 3,000,000 × GH¢1.45 = GH¢4,350,000 Step 3: Calculate the Cost of Debt (K_d) and Market Value of Debt (V_d) Debentures: Nominal value = GH¢1,000,000. Coupon rate = 7%. Redemption value = GH¢100 per GH¢100 nominal. Current market price = GH¢83.60 per GH¢100 nominal. Years to maturity (N) = 2022 - 2018 = 4 years. Annual interest payment (I) = 7% of GH¢100 = GH¢7. Pre-tax cost of debentures (K_d,deb) is calculated using interpolation for Yield to Maturity (YTM): At 12%: 7 × PVAF(12\%, 4) + 100 × PVF(12\%, 4) = 7 × 3.0373 + 100 × 0.6355 = 21.2611 + 63.55 = 84.8111 At 13%: 7 × PVAF(13\%, 4) + 100 × PVF(13\%, 4) = 7 × 2.9745 + 100 × 0.6133 = 20.8215 + 61.33 = 82.1515 K_d,deb = 12\% + (13\% - 12\%) × (84.8111 - 83.60)/(84.8111 - 82.1515) = 12\% + 1\% × (1.2111)/(2.6596) = 12\% + 0.4553\% = 12.46\% Market value of debentures (V_d,deb) = (GH¢1,000,000)/(GH¢100) × GH¢83.60 = GH¢836,000. Bank Loan: Amount = GH¢500,000. Interest rate = 8%. Pre-tax cost of bank loan (K_d,loan) = 8\%. Market value of bank loan (V_d,loan) = GH¢500,000. Total Market Value of Debt (V_d): V_d = V_d,deb + V_d,loan = GH¢836,000 + GH¢500,000 = GH¢1,336,000 Step 4: Calculate the After-Tax Cost of Debt After-tax cost of debentures = K_d,deb(1-T) = 0.1246 × (1 - 0.30) = 0.1246 × 0.70 = 0.08722 or 8.72\%. After-tax cost of bank loan = K_d,loan(1-T) = 0.08 × (1 - 0.30) = 0.08 × 0.70 = 0.056 or 5.60\%. Step 5: Calculate the Weighted Average Cost of Capital (WACC) Total market value of capital (V) = V_e + V_d = GH¢4,350,000 + GH¢1,336,000 = GH¢5,686,000. WACC formula: WACC = K_e ((V_e)/(V)) + K_d,deb(1-T) (V_d,debV) + K_d,loan(1-T) (V_d,loanV) WACC = 0.1680 ((4,350,000)/(5,686,000)) + 0.08722 ((836,000)/(5,686,000)) + 0.056 ((500,000)/(5,686,000)) WACC = 0.1680 × 0.76504 + 0.08722 × 0.14703 + 0.056 × 0.08793 WACC = 0.12852672 + 0.0128289 + 0.00492408 WACC = 0.1462797 or 14.63% ii. Briefly advise the directors of M Co on the suitability of using the WACC calculated in (a) above to discount the expected cash flows of the project. The calculated WACC represents the average cost of capital for M Co's existing business risk profile. It is suitable for discounting the expected cash flows of the new project only if the new product has a similar business risk profile to the company's current operations. If the new product introduces a significantly different level of risk, using the company's overall WACC would be inappropriate and could lead to incorrect investment decisions. In such cases, a project-specific discount rate, reflecting the unique risk of the new venture, should be estimated. Send me the next one 📸

Accepted Answer · 2026-08-18T19:03:46.964Z

i. Calculate the weighted average cost of capital (WACC) for M Co as at 31 December 2018. Assumption: A corporate tax rate of 30\% is assumed as it is not provided in the question. Step 1: Calculate the Cost of Equity (K_e) The cost of equity is calculated using the Dividend Growth Model (K_e = (D_1)/(P_0) + g). Current market price per share (P_0) = GH¢1.45. Most recent dividend (D_0) = 14.1 cents = GH¢0.141. Calculate the dividend growth rate (g) using the geometric mean from 2014 to 2018: g = (D_2018D_2014)^(1)/(n) - 1 = ((0.141)/(0.110))^(1)/(4) - 1 g = (1.281818)^(1)/(4) - 1 = 1.0639 - 1 = 0.0639 or 6.39\% Next year's dividend (D_1) = D_0 (1+g) = GH¢0.141 × (1 + 0.0639) = GH¢0.141 × 1.0639 = GH¢0.1509. Cost of Equity (K_e): K_e = (GH¢0.1509)/(GH¢1.45) + 0.0639 = 0.104069 + 0.0639 = 0.167969 or 16.80\% Step 2: Calculate the Market Value of Equity (V_e) Number of shares = 3 million. Market price per share = GH¢1.45. V_e = 3,000,000 × GH¢1.45 = GH¢4,350,000 Step 3: Calculate the Cost of Debt (K_d) and Market Value of Debt (V_d) Debentures: Nominal value = GH¢1,000,000. Coupon rate = 7%. Redemption value = GH¢100 per GH¢100 nominal. Current market price = GH¢83.60 per GH¢100 nominal. Years to maturity (N) = 2022 - 2018 = 4 years. Annual interest payment (I) = 7% of GH¢100 = GH¢7. Pre-tax cost of debentures (K_d,deb) is calculated using interpolation for Yield to Maturity (YTM): At 12%: 7 × PVAF(12\%, 4) + 100 × PVF(12\%, 4) = 7 × 3.0373 + 100 × 0.6355 = 21.2611 + 63.55 = 84.8111 At 13%: 7 × PVAF(13\%, 4) + 100 × PVF(13\%, 4) = 7 × 2.9745 + 100 × 0.6133 = 20.8215 + 61.33 = 82.1515 K_d,deb = 12\% + (13\% - 12\%) × (84.8111 - 83.60)/(84.8111 - 82.1515) = 12\% + 1\% × (1.2111)/(2.6596) = 12\% + 0.4553\% = 12.46\% Market value of debentures (V_d,deb) = (GH¢1,000,000)/(GH¢100) × GH¢83.60 = GH¢836,000. Bank Loan: Amount = GH¢500,000. Interest rate = 8%. Pre-tax cost of bank loan (K_d,loan) = 8\%. Market value of bank loan (V_d,loan) = GH¢500,000. Total Market Value of Debt (V_d): V_d = V_d,deb + V_d,loan = GH¢836,000 + GH¢500,000 = GH¢1,336,000 Step 4: Calculate the After-Tax Cost of Debt After-tax cost of debentures = K_d,deb(1-T) = 0.1246 × (1 - 0.30) = 0.1246 × 0.70 = 0.08722 or 8.72\%. After-tax cost of bank loan = K_d,loan(1-T) = 0.08 × (1 - 0.30) = 0.08 × 0.70 = 0.056 or 5.60\%. Step 5: Calculate the Weighted Average Cost of Capital (WACC) Total market value of capital (V) = V_e + V_d = GH¢4,350,000 + GH¢1,336,000 = GH¢5,686,000. WACC formula: WACC = K_e ((V_e)/(V)) + K_d,deb(1-T) (V_d,debV) + K_d,loan(1-T) (V_d,loanV) WACC = 0.1680 ((4,350,000)/(5,686,000)) + 0.08722 ((836,000)/(5,686,000)) + 0.056 ((500,000)/(5,686,000)) WACC = 0.1680 × 0.76504 + 0.08722 × 0.14703 + 0.056 × 0.08793 WACC = 0.12852672 + 0.0128289 + 0.00492408 WACC = 0.1462797 or 14.63% ii. Briefly advise the directors of M Co on the suitability of using the WACC calculated in (a) above to discount the expected cash flows of the project. The calculated WACC represents the average cost of capital for M Co's existing business risk profile. It is suitable for discounting the expected cash flows of the new project only if the new product has a similar business risk profile to the company's current operations. If the new product introduces a significantly different level of risk, using the company's overall WACC would be inappropriate and could lead to incorrect investment decisions. In such cases, a project-specific discount rate, reflecting the unique risk of the new venture, should be estimated. Send me the next one 📸

i. Calculate the weighted average cost of capital (WACC) for M Co as at 31 December 2018. ii. Briefly advise the directors of M Co on the suitability of using the WACC calculated in (a) above to discount the expected cash flows of the project.

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i. Calculate the weighted average cost of capital (WACC) for M Co as at 31 December 2018. ii. Briefly advise the directors of M Co on the suitability of using the WACC calculated in (a) above to discount the expected cash flows of the project.

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