QUESTION 6

(a)Calculate the Weighted Average Cost of Capitalof AOI Pty Ltd, using the following information.

Statement of financial position extract

Liabilities

10% debentures ($100 face value) $10,000,000

Shareholders' funds

Paid-up capital - ordinary shares ($1 par) $25,000,000

12% preference shares ($10 par) $5,000,000

Additional information

• The ordinary shares are currently trading at $4.20 per share.
• Commonwealth government bonds trade at 5%.
• The return on the market portfolio is 13.5%.
• AOI's beta is 1.25.
• Its debentures are priced at $96.50 and its preference shares are trading at par.
• The current return on AOI debentures is 2% above the government bond rate.
• No company or personal taxes are levied.
• The existing capital structure is unlikely to change.(20 marks)

(b) In practice, why would management wish to calculate a company's WACC, i.e. what does it represent?(2 marks)

(c) Briefly describe the circumstances under which it would be appropriate for AOI's management to use the WACC calculated in part (a) for project evaluation. Under what specific circumstances would it be inappropriate to use this WACC?(3 marks)