Question 2

Extra-Lux Inc. is evaluating some projects and wishes to determine its weighted average cost of capital (WACC). The Company uses the following sources of capital to finance its operations:

• Ordinary shares with a book value of $500,000 ($1 par). The current market price is $4 per share.

• The debentures are currently priced at $82.50 per unit. The book value of the debentures is $400,000 ($100 par). Its current return is 5% p.a. above the Government bonds rate.

Extra-Luxs beta is 1.5. The U.S. Government Treasury bonds are trading at 5% p.a. currently. The return on the market portfolio is 11% p.a.

Required:

If Extra-Lux pays tax at 30% p.a., what is the WACC of Extra-Lux? Show all workings. (5 marks)