INSTRUCTIONS: This question contains three (3) parts. Answer all parts of the questions. Clearly label your response to each part using bold text. For example: Part a): Your response...

(a) The weighted average cost of capital (WACC) can be calculated as

where E is the market value of equity, D is the market value of debt, V = E + D, k_e is the cost of equity, k_d is the cost of debt and t is the tax rate.

Briefly explain why k_e is not multiplied by (1 - t) in this WACC?

(2 marks)

(b) Using a corporate tax rate of 30%, calculate Spywares after tax WACC based on the following information.

Spyware Ltd is financed through debt and equity. Currently, a Spyware share sells for $10.50 and 1 million of these shares have been issued. Analysis indicates that the appropriate Beta for a Spyware share is 1.25. Further, the risk-free rate is 5% p.a. and the expected market return is 13% p.a. Spyware has also issued 100,000 bonds. Each of these bonds has a face value of $100, three years to maturity, pay an annual coupon of 10% and currently trade for $105.154. Finally, Spyware has a bank loan with a balance of $2,000,000. The interest rate on this loan is 10% p.a.

(7 marks)

(c) Outline one reason why the WACC from (b) may not be the appropriate WACC for evaluating all of Spywares capital investment decisions.