ABC Ltd has decided to use the weighted average cost of capital (WACC) to discount the...

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ABC Ltd has decided to use the weighted average cost of capital (WACC) to discount the after-tax cash flows associated with project evaluation. You have been given the task of determining the after-tax WACC of the firm. You are informed that ABC Ltd uses the following securities to fund its operation: - 40,000 individual bonds with 6%, 10-year $1,000 face value that were issued 5 years ago have 5 years remaining and offer a coupon that is paid half-yearly. The current market interest rate for these bonds is 7% per annum. - 2,500,000 ordinary shares, with an expected dividend of 60 cents next year. Dividends are expected to grow at 5% per annum perpetually. The current share price is $30. . Using the historical data, the covariance between the returns of ABC Ltd and the returns of S&P/ASX200 is found to be 0.0015 and the standard deviation of S&P/ASX 200 returns is 0.04. The risk-free rate is currently 3% per annum, and the market risk premium is 6% per annum. - For the cost of equity calculation, ABC Ltd has decided to use the average of two values obtained from the constant growth model and the CAPM. * 1,000,000 preference shares, which pay an annual dividend of 50 cents. Each preference share trades at a market price of $10. - The company tax rate is 30%. Required: a) Compute the WACC. (16 marks) b) ABC Ltd is considering an acquisition of Moon Ltd whose WACC is 10%. Your company's purchase of Moon Ltd will cost 50 million, and will generate cash flows of $10 million per year for the next 10 years and the cost of environmental clean-up is expected to be $500,000 per year starting from year 1 in perpetuity. What is the NPV of the acquisition? Should your company go ahead with the acquisition and why? (4 marks) ABC Ltd has decided to use the weighted average cost of capital (WACC) to discount the after-tax cash flows associated with project evaluation. You have been given the task of determining the after-tax WACC of the firm. You are informed that ABC Ltd uses the following securities to fund its operation: - 40,000 individual bonds with 6%, 10-year $1,000 face value that were issued 5 years ago have 5 years remaining and offer a coupon that is paid half-yearly. The current market interest rate for these bonds is 7% per annum. - 2,500,000 ordinary shares, with an expected dividend of 60 cents next year. Dividends are expected to grow at 5% per annum perpetually. The current share price is $30. . Using the historical data, the covariance between the returns of ABC Ltd and the returns of S&P/ASX200 is found to be 0.0015 and the standard deviation of S&P/ASX 200 returns is 0.04. The risk-free rate is currently 3% per annum, and the market risk premium is 6% per annum. - For the cost of equity calculation, ABC Ltd has decided to use the average of two values obtained from the constant growth model and the CAPM. * 1,000,000 preference shares, which pay an annual dividend of 50 cents. Each preference share trades at a market price of $10. - The company tax rate is 30%. Required: a) Compute the WACC. (16 marks) b) ABC Ltd is considering an acquisition of Moon Ltd whose WACC is 10%. Your company's purchase of Moon Ltd will cost 50 million, and will generate cash flows of $10 million per year for the next 10 years and the cost of environmental clean-up is expected to be $500,000 per year starting from year 1 in perpetuity. What is the NPV of the acquisition? Should your company go ahead with the acquisition and why? (4 marks)

Answer rating: 100% (QA)

a To compute the WACC we need to calculate the cost of debt cost of equity and the weights of debt a... View the full answer