Rob plc have decided that in order to make better investment appraisal decisions they need to re-calculate the companys cost of capital. The following information is extracted from the companys statement of financial position (balance sheet):

Fixed assets: 890

Current assets: 370

Current liabilities: (220)

Non-current liabilities:

5% Bonds (100 par) redeemable in 7 years (160)

4% Irredeemable Bonds (100 par) (190)

Bank Loan (120)

Share capital and reserves

Ordinary Shares (nominal value 50p) 180

7% Preference shares (1 nominal value) 100

Reserves 290

Additional information:

The risk-free rate of return on short-dated government bonds is currently 3%. The market risk premium has been estimated at 7% and the companys beta is 1.5. The companys ordinary share price is 3 and the preference share price is 0.8. The irredeemable bonds are currently trading at a 5% discount to par value and the redeemable bonds are currently trading at 105. The rate of interest payable on the loan is 8% and the corporation tax rate is 25%

a) Explain the role of the weighted average cost of capital (WACC) in financial decision-making.

b) Calculate the cost of each source of finance used by Rob plc, including their reserves

c) Discuss why market values rather than book values should be used when calculating the WACC.

d) Calculate the weighted average cost of capital for Rob plc using market weightings.

e) Using diagrams explain and discuss Miller and Modiglianis (1963) view of capital structure.

f) Discuss the practical problems that maybe encountered when calculating the WACC.