Transuburban Ltd, a major construction company, is planning to submit a quote to
build the Robert Mitcham Tollway. However, the company finance manager is unsure
of the required rate of return to use in her calculations. She has offered you a free G
tag if you could provide information on the appropriate ‘discount rate’. To help you
with your calculations, she has tabled the following extracts from the company’s
latest Financial Statements
Selected Financial data as at 31 December 2003:
SHAREHOLDERS FUNDS
Ordinary shares Issue price $2.00 each, fully paid $20,000,000
10% Preference shares Issue price $2.00 each, fully paid $10,000,000
Retained Profit $14,500,000
LIABILITIES
Accounts Payable $ 1,500,000
Debentures $24,000,000
Bank Overdraft $ 8,000,000
Provision for Long Service Leave $10,000,000
Additional Information:
• 24,000 debentures have been issued with a coupon rate of 6.5%. They
mature in 5 years time. Similar debentures are currently yielding 10%.
• The bank overdraft carries an interest rate of 8%. Interest is charged monthly.
• The current dividend paid is 16 cents per share. This dividend is expected to
grow indefinitely at 5% per annum.
• The expected market return on Transuburban Ltd ordinary shares is 13%.
• The risk free rate of interest is 6%.
• The current market price of the Preference Shares $1.80.
• The company tax rate is 30 %.
Year 0 1 2 3 4 5
STEP 1 – Calculate Taxable Income
Increased Revenue 100,000 100,000 100,000 100,000 100,000
Cost savings 30,000 30,000 30,000 30,000 30,000
Depreciation -70,000 -70,000 -70,000 -70,000 -70,000
Gain/Loss on Sale for new machine 20,000
Taxable income 0 60,000 60,000 60,000 60,000 80,000
Tax @ 30% 0 -18,000 -18,000 -18,000 -18,000 -24,000
STEP 2 – Include All Cash Flows
Tax refund/paid 0 -18,000 -18,000 -18,000 -18,000 -24,000
Initial Cost -350,000
Increased Revenue 100,000 100,000 100,000 100,000 100,000
Cost savings 30,000 30,000 30,000 30,000 30,000
Salvage value of machine 20,000
Net Cash Flow -350,000 112,000 112,000 112,000 112,000 126,000
PVCF @ 12% -350000 93333 77778 64815 54012 50637
Page 10
Required: Calculate the weighted average cost of capital (to 2 decimal places). Show
all workings.
MV Cost WACC
Debentures 20815739 35.39 7.0 .024773
Bank Overdraft 8000000 13.6 5.8 .007888
Pref.Shares 9000000 15.3 11.1 .016983
Ord Shares 21000000 35.71 13.0 .046423
Total 58815739 100 .096067
WACC = 9.6%