Auto Motors Plc is a listed automotive company financed by a mixture of debt and equity. The company’s finance department is about to undertake its annual revision of the weighted average cost of capital (WACC) for use in all of the company’s investment appraisals for the forthcoming year. The following information on the company’s long-term financing was available as at 31 May 2023. £m 220 million ordinary shares of 25 pence each 55 Share premium 23 Revaluation reserve 26 Retained earnings 33 12% loan stock (2025) 100 The loan stock interest for the year has just been paid. Interest on this loan will be paid on 31 May 2024 and 2025. On 31st of May 2025, the loan stock will be redeemed at par in cash. The company has also just paid a dividend on its subsidiary shares of 23 pence. This was the total dividend for the year. Dividends have grown by an average annual rate of 5% over recent years, but year-to-year growth has been as high as 10% and as low as 2% during individual years. The shares are currently quoted at 370 pence each, and the loan stock at £104 (per £100 nominal). The company’s corporation tax is 19%. Several of the directors believe that the company is relatively low-geared and there is talk of making a substantial loan stock issue during the forthcoming year. Required: a) Determine Auto Motors Plc’s WACC, ignoring any possibility of a further loan stock issue (show all workings clearly). b)Explain the conditions under which a company’s WACC is appropriate to use as the cost of capital when evaluating the company’s projects.
Auto Motors Plc is a listed automotive company financed by a mixture of debt and equity. The company’s finance department is about to undertake its annual revision of the weighted average cost of capital (WACC) for use in all of the company’s investment appraisals for the forthcoming year. The following information on the company’s long-term financing was available as at 31 May 2023.
£m
220 million ordinary shares of 25 pence each 55
Share premium 23
Revaluation reserve 26
12% loan stock (2025) 100
The loan stock interest for the year has just been paid. Interest on this loan will be paid on 31 May 2024 and 2025. On 31st of May 2025, the loan stock will be redeemed at par in cash. The company has also just paid a dividend on its subsidiary shares of 23 pence. This was the total dividend for the year. Dividends have grown by an average annual rate of 5% over recent years, but year-to-year growth has been as high as 10% and as low as 2% during individual years.
The shares are currently quoted at 370 pence each, and the loan stock at £104 (per £100 nominal). The company’s corporation tax is 19%.
Several of the directors believe that the company is relatively low-geared and there is talk of making a substantial loan stock issue during the forthcoming year.
Required:
a) Determine Auto Motors Plc’s WACC, ignoring any possibility of a further loan stock issue (show all workings clearly).
b)Explain the conditions under which a company’s WACC is appropriate to use as the cost of capital when evaluating the company’s projects.
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