The Equity Shares Of A Company Are Quoted As ₹105. The Company Plans To Declare A Dividend Of ₹10 Per Share. The Growth Rate Of Dividend Is 5%. Tax Rate Is 50%. Calculate W.A.C.C When The Capital Structure Of The Company As On 31st March, 2020 Shows

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The Equity Shares of a company are quoted as ₹105. The company plans to declare a dividend of ₹10 per share. The growth rate of dividend is 5%. Tax rate is 50%. Calculate W.A.C.C when the capital structure of the company as on 31st March, 2020 shows

In this article, we will discuss how to calculate the Weighted Average Cost of Capital (WACC) of a company. WACC is a crucial metric used by companies to determine their cost of capital, which is the minimum return that investors expect from their investment in the company. The WACC is calculated by taking into account the cost of equity and the cost of debt, and then applying a weighted average to these two costs based on the company's capital structure.

The capital structure of a company refers to the mix of different sources of financing used by the company to fund its operations. The two main sources of financing are equity and debt. Equity refers to the ownership shares of the company, while debt refers to the loans and other borrowings that the company has taken to fund its operations.

As on 31st March, 2020, the capital structure of the company shows that the company has a mix of equity and debt financing. The company has a total of ₹100 crores in equity and ₹50 crores in debt. The equity is divided into 10,000 shares, each with a face value of ₹10 and a market value of ₹105.

The cost of equity is the return that investors expect from their investment in the company. It is calculated using the dividend growth model, which is given by the formula:

D0 / P0 = Rg + g

Where:

  • D0 is the dividend per share
  • P0 is the market price per share
  • Rg is the cost of equity
  • g is the growth rate of dividend

In this case, the dividend per share is ₹10, the market price per share is ₹105, and the growth rate of dividend is 5%. Plugging in these values, we get:

10 / 105 = Rg + 0.05

Solving for Rg, we get:

Rg = 9.52%

The cost of debt is the interest rate that the company pays on its debt. It is calculated using the formula:

Cost of debt = (Interest paid / Total debt) x 100

In this case, the interest paid is ₹5 crores and the total debt is ₹50 crores. Plugging in these values, we get:

Cost of debt = (5 / 50) x 100 = 10%

The tax rate is the rate at which the company is taxed on its profits. In this case, the tax rate is 50%.

The WACC is calculated using the formula:

WACC = (E / (E + D)) x Re + (D / (E + D)) x Rd x (1 - T)

Where:

  • E is the total equity
  • D is the total debt
  • Re is the cost of equity
  • Rd is the cost of debt
  • T is the tax rate

In this case, the total equity is ₹100 crores, the total debt is ₹50 crores, the cost of equity is 9.52%, the cost of debt is 10%, and the tax rate is 50%. Plugging in these values, we get:

WACC = (100 / (100 + 50)) x 9.52 + (50 / (100 + 50)) x 10 x (1 - 0.5) = 8.24%

In conclusion, the WACC of the company is 8.24%. This means that the company's cost of capital is 8.24%, which is the minimum return that investors expect from their investment in the company. The WACC is an important metric used by companies to determine their cost of capital, and it is calculated by taking into account the cost of equity and the cost of debt, and then applying a weighted average to these two costs based on the company's capital structure.

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  • Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics, 5(2), 147-175.
    WACC Q&A =============

Frequently Asked Questions about Weighted Average Cost of Capital (WACC)

Q: What is WACC?

A: WACC, or Weighted Average Cost of Capital, is a financial metric that represents the average cost of capital for a company. It takes into account the cost of equity and the cost of debt, and applies a weighted average to these two costs based on the company's capital structure.

Q: Why is WACC important?

A: WACC is an important metric because it represents the minimum return that investors expect from their investment in the company. It is used by companies to determine their cost of capital, and is a key input in capital budgeting decisions.

Q: How is WACC calculated?

A: WACC is calculated using the formula:

WACC = (E / (E + D)) x Re + (D / (E + D)) x Rd x (1 - T)

Where:

  • E is the total equity
  • D is the total debt
  • Re is the cost of equity
  • Rd is the cost of debt
  • T is the tax rate

Q: What are the components of WACC?

A: The components of WACC are:

  • Cost of equity (Re): the return that investors expect from their investment in the company
  • Cost of debt (Rd): the interest rate that the company pays on its debt
  • Tax rate (T): the rate at which the company is taxed on its profits
  • Capital structure (E/D): the mix of equity and debt financing used by the company

Q: How does WACC relate to capital structure?

A: WACC is directly related to the capital structure of the company. The capital structure is the mix of equity and debt financing used by the company, and WACC takes this into account when calculating the average cost of capital.

Q: What are the implications of WACC for capital budgeting?

A: WACC is a key input in capital budgeting decisions, as it represents the minimum return that investors expect from their investment in the company. Companies use WACC to evaluate the profitability of potential investments and to determine whether they should proceed with a project.

Q: How does WACC compare to other financial metrics?

A: WACC is a more comprehensive metric than other financial metrics, such as the cost of equity or the cost of debt. It takes into account the capital structure of the company and the tax rate, making it a more accurate representation of the company's cost of capital.

Q: What are the limitations of WACC?

A: WACC has several limitations, including:

  • It assumes that the company's capital structure is stable and will not change in the future
  • It assumes that the cost of equity and the cost of debt are constant over time
  • It does not take into account other sources of financing, such as hybrid securities

Q: How can WACC be used in practice?

A: WACC can be used in a variety of ways in practice, including:

  • Evaluating the profitability of potential investments
  • Determining whether to proceed with a project
  • Setting the company's cost of capital
  • Comparing the company's cost of capital to that of its competitors

WACC is a critical metric for companies to understand their cost of capital and make informed capital budgeting decisions. By understanding the components of WACC and how it relates to capital structure, companies can use WACC to evaluate the profitability of potential investments and determine whether they should proceed with a project.