Question 3

Tlc Motors Plc is a listed automotive company financed by a mixture of debt and equity. The companys finance department is about to undertake its annual revision of the weighted average cost of capital (WACC) for use in all of the companys investment appraisals for the forthcoming year. The following information on the companys long-term financing was available as at 31 May 2022.

220 million ordinary shares of 25 pence each 55M

Share premium 23M

Revaluation reserve 26M

Retained earnings 33M

12% loan stock (2024) 100M

The loan stock interest for the year has just been paid. Interest on this loan will be paid on 31 May 2023 and 2024. On 31st of May 2024, 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 companys 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.

a) Determine Tlc Motors Plcs weighted average cost of capital (WACC), ignoring any possibility of a further loan stock issue (showing all workings clearly). (22 marks)

b) Explain the conditions under which a companys WACC is appropriate to use as the cost of capital when evaluating the companys projects. (8 marks)