ABC company has the following capital structure as on 30 June 2020 Ordinary share (200,000 shares) sh 4,000,000 10% preference shares ( 100,000) 1,000,000 14% debentures 3,000,000 Total 8,000,000 The share of the company sells for sh 20. It is expected that the company will pay next year a dividend of sh 2 per share which will grow at 7% forever. The preferred stock is selling at par. Assume a 30% tax rate. Required: The weighted average cost of capital on the existing capital structure.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
- ABC company has the following capital structure as on 30 June 2020
- Ordinary share (200,000 shares) sh 4,000,000
- 10%
preference shares ( 100,000) 1,000,000 - 14% debentures 3,000,000
- Total 8,000,000
- The share of the company sells for sh 20. It is expected that the company will pay next year a dividend of sh 2 per share which will grow at 7% forever. The preferred stock is selling at par. Assume a 30% tax rate.
- Required:
The weighted average cost of capital on the existing capital structure.
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