Question
The directors of Koko Limited are considering opening a new factory to manufacture a new product at a cost of $3.0 million. During the last
The directors of Koko Limited are considering opening a new factory to manufacture a new product at a cost of $3.0 million. During the last 5years, the company has had 3 million shares in issue. The current market price of these shares (at 31 December 20X8) is $1.45 ex-dividend. The company pays only one dividend each year (on 31 December) and dividends for the last five years have been as follows: Koko Limited currently has in issue $1 million 7% debentures redeemable on31 December 20Y2 at par. The current market price of these debentures is$83.60 ex-interest, and the interest is payable in one amount each year on 31 December. The company also has outstanding a $500,000 bank loan repayable on 31 December 20Y7. The rate of interest on this loan is variable, being fixed at 3% above the bank's base rate which is currently 5%. Required: (a)Calculate the weighted average cost of capital (WACC) for Koko Limited as at 31 December 20X8 (15 marks) (b)Explain the terms business risk and financial risk and the significance of each in using an existing WACC to appraise a future project. (7 marks) (c)Briefly advise the directors of Koko Limited on the suitability of using the WACC calculated in (a) above to discount the expected cash flows of the project (3 marks)
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