7.a)Calculate the company cost of capital (or WACC) of Kangas Ltd, a company that commenced operations many years ago. Relevant details relating to the company include the following.

Extract from statement of financial performance

LiabilitiesDebentures ($100 par, 12.5% couponannual) $4,000,000

Preference shares ($3 par, 7% cumulative) 1,500,000

Owners equity

Ordinary shares ($0.50 par) $7,500,000

Retained earnings 2,500,000

Additional information

An interest payment in relation to the debentures has just been made, and they mature three years from today.The market rate of interest on the debentures is 15%. (Use this to calculate the market value of the debt.)

The preference shares are trading on the market at $3.00, and a dividend of 21 per share has just been paid.

Forecasts in relation to market returns are as follows: expected risk-free rate of return = 6.5%; expected return on the market portfolio = 16.0%; and the systematic risk of Kangas ordinary shares is the same as the market portfolios systematic risk. These shares are trading on the market at $0.63 each.

b)In practice, why would management wish to calculate a companys WACC, i.e. what does it represent?

(c)Briefly describe the circumstances under which it would be appropriate for Kangas management to use the WACC calculated in part (a) for project evaluation. Under what specific circumstances would it be inappropriate to use this WACC?