You are attempting to identify the WACC of a company for whom you are working. As most of the shareholders are Australian residents you have assume that the company would maximise after tax cash flows and is therefore a taxation category 2 company.

The latest balance sheet for the company shows:

Long Term Debt Book Value ($)

Bonds: Issued at par: $1,000 400,000

Annual coupon of 9%

3 years to maturity

Equity

Preference Shares: 600,000

100,000 shares outstanding

Ordinary Shares: 4,000,000

8,000,000 shares outstanding

The companys bank has advised that the interest rate on any new debt finance provided for new projects would be 6% p.a.

The companys preference shares currently sell for $7.25 each and pay an annual dividend of $1.05 per share.

The companys existing ordinary shares currently sell for $0.43 each and pay a dividend per share of $0.08 which has just been paid to shareholders. Historically, dividends have increased at an annual rate of 2% p.a. and are expected to continue to do so in the future.

Pulleys and Plugs company tax rate is 30%.

1. Determine the market value proportions of debt, preference shares and ordinary equity comprising the companys capital structure. (6 marks)
2. How does the cost of debt capital relate to the value of a debt security?
3. Calculate the after-tax costs of capital for each source of finance.
4. Determine the after-tax weighted average cost of capital for the company.