Pacific Coast Mining Pty Ltd,an Australian listed company,has 1 000 000 ordinary shares outstanding and the current market price per share is $13.The required rate of return for the ordinary shares is estimated to be 12%.They have issued bonds with a face value of $8 000 000 but the current market value based on a yield to maturity of 7.5% is $7 750 250.If the corporate tax rate is 30% what is the weighted average cost of capital assuming a classical tax system?

Question

Quizplus · Accepted Answer

Step 1: Calculate the cost of equity

Cost of equity = (Current market price per share / Earnings per share) + Growth rate

To find Earnings per share, we look at the company's financial statements, but since no information is given in the question, we cannot calculate it. Hence, we assume that the company has a constant growth rate of 5% (generally for mining companies) and we use the dividend discount model.

Dividend discount model = (Dividend per share / Current market price per share) + Growth rate

Assuming Pacific Coast Mining Pty Ltd pays a dividend of $0.75 per share, the dividend discount model would be:

DDM = (0.75 / 13) + 5% = 11.8%

Therefore, cost of equity = 11.8%

Step 2: Calculate the cost of debt

Cost of debt = Yield to maturity * (1 - Corporate tax rate)

Cost of debt = 7.5% * (1 - 0.3) = 5.25%

Step 3: Calculate the weights of equity and debt

Weight of equity = (Number of shares outstanding * Current market price per share) / Total firm value
Total firm value = Market value of equity + Market value of debt

Weight of equity = (1,000,000 * 13) / (13,000,000 + 7,750,250) = 56.8%

Weight of debt = (Market value of debt) / (Market value of equity + Market value of debt)

Weight of debt = 43.2%

Step 4: Calculate the weighted average cost of capital (WACC)

WACC = (Weight of equity * Cost of equity) + (Weight of debt * Cost of debt)

WACC = (0.568 * 0.118) + (0.432 * 0.0525) = 0.0948 or 9.48%

Therefore, the weighted average cost of capital (WACC) assuming a classical tax system is 9.48%. The answer is D) 9.48%.

Pacific Coast Mining Pty Ltd,an Australian Listed Company,has 1 000