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    Weighted average cost of capital for BrainM plc

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    A Company (BrainM plc) has 10 million ordinary shares of 50p each in issue out of an authorised ordinary share capital of 12 million. The company has recently paid a dividend of 12p per share on the ordinary shares, which are currently listed at 112p ex div. The dividend growth rate has recently been a little under 10% p.a., and this is expected to continue for the foreseeable future. Extracts from the group balance sheet are as follows:

    BrainM plc
    £000
    Ordinary shares 5,000
    Share premium 3,920
    Reserves 7,490
    Minority interests 1,790
    3% irredeemable debentures 3,000
    6% redeemable debentures 4,000
    Bank loans 7,080

    Interest on the debentures is payable annually, and both of the current year's payments are impending. The current market prices for £100 nominal value stock are £31.50 and £103.50 for the 2% and 6% debentures, respectively (both values being cum interest). The 6% debentures are redeemable in ten years' time at a premium of 2.5%. The bank loans currently bear interest at 2% p.a. above base rate (which is currently 3.5%) and are repayable in eight years. The effective corporation tax rate for BrainM plc is 35%.

    How would I calculate the weighted average cost of capital to be used by the company in appraising the viability of the projects? Can you please explain, so i can understand how and why you come about it.

    If anyone can help me, it would be much appreciated. Thank you in advanced.

    If more credits are needed to solve the problem, please let me know.

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    Solution Preview

    Response is attached,

    Thanks

    Firm's optimal capital structure is that mixture of debt and equity than minimizes its weighted average cost of capital (WACC). While this is a true statement, it glosses over a number of interesting issues on the path to that grand conclusion on the WACC-minimizing capital structure.
    For example, since the after-tax cost of debt is lower than equity for many corporations, why not use debt only or mostly? It ...

    Solution Summary

    This provides the steps to calculate the weighted average cost of capital

    $2.19