Question $3$

Auto Motors Plc is a listed automotive company financed by a mixture of debt and equity. The

company$$s finance department is about to undertake its annual revision of the weighted

average cost of capital $($WACC$)$ for use in all of the company$$s investment appraisals for the

forthcoming year. The following information on the company$$s long$-$term financing was

available as at $31$ May $2023.$

$$m

$220$ million ordinary shares of $25$ pence each $55$

Share premium $23$

Revaluation reserve $26$

Retained earnings $33$

$12\%$ loan stock $(2025)100$

The loan stock interest for the year has just been paid. Interest on this loan will be paid on $31$

May $2024$ and $2025.$ On $31$st of May $2025,$ the loan stock will be redeemed at par in cash.

The company has also just paid a dividend on its subsidiary shares of $23$ pence. This was

the total dividend for the year. Dividends have grown by an average annual rate of $5\%$ over

recent years, but year$-$to$-$year growth has been as high as $10\%$ and as low as $2\%$ during

individual years.

The shares are currently quoted at $370$ pence each, and the loan stock at $104($per $100$

nominal$).$ The company$$s corporation tax is $19\%.$

Several of the directors believe that the company is relatively low$-$geared and there is talk of

making a substantial loan stock issue during the forthcoming year.

Required:

a$)$ Determine Auto Motors Plc$$s WACC, ignoring any possibility of a further loan stock issue

$($show all workings clearly$).$

$(22$ marks$)$

b$)$ Explain the conditions under which a company$$s WACC is appropriate to use as

the cost of capital when evaluating the company$$s projects.

$(8$ marks$)$