i. The company is financed by 50 million K1 shares with a market price of K1.20 and reserves and share premium accounts totaling K100 million; ii. A dividend of K2.25 per share has just been paid, an increase of 20 percent on the previous year (this is the normal annual increase in dividends for the company); iii. The rate of corporation tax is 30 percent; iv. The company’s shares have a beta of 1.6; v. The return on government stocks is 4.5 percent and the return on the market is 14 percent; vi. In addition to share capital the company has K20 million (at market value) debt in its capital structure at a pre-tax cost of 12 percent. Required: The MD has recently read that there are different methods available for calculating the cost of equity and is particularly interested that you calculate the overall cost of capital using the dividend valuation model first and the capital asset pricing model second. Prepare a report providing the managing director with the figures he requires, explaining any resulting differences.
With over 95,000 employees on five continents, Germany-based BASF is a major
international company. It operates in a variety of industries, including agriculture, oil and
gas, chemicals, and plastics. In an attempt to increase value, BASF launched BASF
2015, a comprehensive plan that included all functions within the company and
challenged and encouraged all employees to act in an entrepreneurial manner. The
major financial component of the strategy was that the company expected to earn its
weighted average cost of capital, or WACC, plus a premium. So, what exactly is the
WACC? The WACC is the minimum return a company needs to earn to satisfy all of its
investors, including stockholders, bondholders, and preferred stockholders. In 2007, for
example, BASF pegged its WACC at 9 percent, and it increased this figure to 10
percent in 2008.
You have recently been appointed company secretary to Finozest Solutions PLC and
have been asked by the Managing Director (MD) to estimate the company’s weighted
average cost of capital. You have ascertained the following information:
i. The company is financed by 50 million K1 shares with a market price of K1.20 and
reserves and share premium accounts totaling K100 million;
ii. A dividend of K2.25 per share has just been paid, an increase of 20 percent on the
previous year (this is the normal annual increase in dividends for the company);
iii. The rate of corporation tax is 30 percent;
iv. The company’s shares have a beta of 1.6;
v. The return on government stocks is 4.5 percent and the return on the market is 14
percent;
vi. In addition to share capital the company has K20 million (at market value) debt in its
capital structure at a pre-tax cost of 12 percent.
Required:
The MD has recently read that there are different methods available for calculating the
cost of equity and is particularly interested that you calculate the overall cost of capital
using the dividend valuation model first and the
Prepare a report providing the managing director with the figures he requires, explaining
any resulting differences.
Step by step
Solved in 4 steps with 3 images
