Financial statement of comprehensive income R'000

Income 1000

Gross profit 800

Operating profit 600

Finance charges (interest payments) 100

Tax 140

Net profit 360

Summarized statement of financial position

Total assets 11 000

Fixed assets 10 000

Current assets 1000

Total liabilities 7000

Interest bearing 7000

Equity 4000

Market data obtained from publicly available resources:

Current share price 150c

Beta 1.2

Bond YTM 3%

Industry average bond YTM 2%

Most recent dividend 5c

Estimated dividend growth rate 10 %

Shares outstanding 10 000 000

Bonds issued 700

Bond principle R10 000

Bond time to maturity 3 years

Excerpt from internal communication:

"... we have an established target debt ratio (total liabilities to total assets) of 50%. Despite our favorable credit rating, we aim to maintain a long-term average debt ratio of 50% in order to maintain borrowing capacity. Currently, the company's structure exceeds this target ratio due to the company recently undertaking some lucrative projects which were financed with debt..."

Assume a tax rate of 28%, a risk free rate of 5% and a market risk premium of 6%.

1. How do you determine WACC at book costs and book weights
2. How do you determine WACC at market costs and market weights
3. How do you determine WACC at market costs and target weights
4. How do we indicate which one of the three WACC's that you have calculated is the most correct one for the company to use.
5. Briefly discuss why you chose to use this WACC.
6. How do we use the free cash flow to the firm in order to determine the value of the company using the three respective WACC's that were calculated in 1,2 and 3. (You should do three calculations using the three WACC's as the relevant cost in the formula). Assume the following: depreciation charges is R5m, the company will see growth in FCF of 5% per annum for the near future and there are no expected changes in working capital requirements or capital expenditure.

Hints:

For the book cost of equity, use the dividend discount model and for market costs, CAPM.

Assume that the interest bearing debt is comprised solely of the issued bonds.

The bond coupon rate can be determined from the financial statements.