LECTURE 7 APPENDIX: A step-by-step estimation of the WACC (Read this before attempting the case study) The balance sheet of a firm reveals the following liabilities and equity: Bank overdraft Accounts payable Provisions Bank mortgage loan Bonds Deferred tax liabilities Preference shares Shareholders equity Share capital Reserves Retained earnings $('000) 1000 4266 2934 5000 3000 3600 4000 2000 5000 18000 $50000

Additional information: a) The current interest rate on bank overdraft is 9%. b) The current mortgage loan has two years remaining to maturity. The loan taken out three years ago with a bank carried an interest of 9% per annum on the reducing balance. A new 2-year loan will cost 10% on similar terms. c) The bonds outstanding pay a coupon of 11% once a year with the face value to be repaid in six years. A merchant banker suggests that the current yield on a new 6-year bond issue is 10.5%. d) Preference shares were issued with a face value of $100 and a dividend rate of 9%. They were recently traded at $90. e) There are 2 million ordinary shares outstanding. The last trade of ordinary shares was $47. New shares can be sold for $45 net of issue costs. The beta of the shares is estimated to be 1.06. 10-year government bonds are currently yielding 5.52% and the expected market risk premium is 8%. f) The tax rate is 30 cents in the dollar. Step 1: calculate the market value of outstanding securities in order to estimate the weights provided by each source of financing Bank overdraft (short-term debt) MV = BV = $1000 Mortgage loan (reducing balance) Annual payment = 5000 / [(1 - 1.09-2)/0.09] = $2842 MV = 2842*[(1 - 1.10-2)/0.10] = $4933

Bonds (interest-only debt) Annual interest = 3000(0.11) = $330 MV = 330*[(1 - 1.105-6)/0.105] + 3000(1.105)-6 = $3064 Preference shares MV = number of shares * price per share = (4000/100) * $90 = $3600 Ordinary shares MV =