Question 1

Read through the information below and answer the questions that follow.

• a.This part of the question has three different scenarios for the calculation of weighted average cost of capital (WACC) and asks you to explain some issues surrounding it.
  • i.Crypton SRL has 5 million shares in issue. The current market price is 5 per share. The companys debt is publicly traded on the Paris Stock Exchange and the most recent quote for its price was at 70% of face value. The debt has a total face value of 10 million and Cryptons credit risk premium is currently 5%. The risk-free rate is 3% and the equity market risk premium is 5%. The companys beta is estimated at 1.4 and its corporate tax rate is 40%. Calculate Crypton SRLs WACC.
  • ii.Joyner Ltd has an average market cost of borrowing of 6% per year and an equity beta of 1.2. Joyner has a consistent ratio of debt to equity of 2:1 and a tax rate of 35%. The expected return on the market portfolio is 20% and the expected risk-free rate is 3%. Calculate the WACC for Joyner Ltd.
  • iii.Given the following data, calculate Jolly Giant PLCs weighted average cost of capital (WACC). Risk-free rate (Rf) = 4% p.a. Jolly Giant PLCs Beta () = 0.6 Jolly Giant PLCs share price = 4.00 Number of Jolly Giant PLC shares in issue = 7.8 million Jolly Giant PLCs credit risk premium (Rp) = 3% p.a. Jolly Giant PLCs market value of debt (D) = 18m Equity risk premium (E(Rm) Rf) = 8% p.a. Jolly Giant PLCs corporate tax rate (t) = 25%
  • iv.The companies in (i) and (ii) above have a beta greater than one. Explain what this means and the benefits to managers of knowing the cost of equity capital of their companies.
• b.How do credit ratings agencies help facilitate efficient capital markets?
• c.A firm is planning to increase its international business without changing its leverage. On the basis of the CAPM, how would this affect the cost of equity?