c. The following balance sheet as 31 December 2015 was extracted trom Melbourme
ID: 2811284 • Letter: C
Question
c. The following balance sheet as 31 December 2015 was extracted trom Melbourme Company Sources of finance Commercial bills Bank overdraft Bonds 10% Preference shares Book value 200,000 100,000 300,000 200,000 600,000 shares (60,000Rs. 1 The following additional information is given by the company financial managor I. The commercial bills have a current interest yield of 8.00% per annum. The commercial 2. The interest rate on the bank overdraft is 10% per annum, calculated daily and charged to 3, There are 300 bonds, each with a face value of Rs.1000 and a coupon rate of 10% per bill matures on 31 March 2016 but will be replaced by a further issue at that date. company account semiannually annum, payable on semiannually (30 June and 31 December). The bonds will be redeemed at their face value on 31 December 2017. On December 2015 the market value of each bond was Rs.1100 4. The preference shares are redeemable and have a face value of Rs. 10. Dividends are payable on 30 June and 31 December each year. The preference shares will be redeemed at their face value on 31 December 2018. On 3 December 2015, the market value of each preference share was Rs. 15 5. The company pays dividends ons ordinary shares once a year on 31 December. The company has paid Rs. 2 per share as dividends and these dividends will be increased by Rs. 0.5 in the next year. On December 2015, the market price of each ordinary share was Rs. 20. 6. The company income tax rate is 35%. Calculate the followings by considering the above mentioned information of Melbourne Company i. Average cost of debt on market value ii. Average cost of equity on market value iii. Average cost of funds on market value (6 Marks) (6 Marks) (2 Marks)Explanation / Answer
Average cost of debt on market value Debt Component A Commercial Bills 200,000 B Cost(Before Tax) 8% C=B*(1-0.35) After tax cost =8*(1-0.35)= 5.20% D Bank Overdraft 100,000 Cost 10% componded daily E Effective interest rate=((1+(0.1/365))^365)-1 10.52% F=E*(1-0.35) After tax cost 6.84% Bonds G Market Value of Bonds 330,000 (1100*300) Face Value of Bond 1,000 Semi-Annual Coupon payment per Bond 50 (1000*0.1)/2 Number of semi annual period to maturity 4 Semi annual Yield to maturity 2.35% (Using Rate function of excelwith Nper=4, Pmt=50, PV=-1100,FV=1000) Annual yield=2*2.35= 4.70% H Cost of Bonds(Before tax) 4.70% I=H*(1-0.35) After tax cost of Bond 3.06% J=A+D+G Total Debt Component market value 630,000 W1=A/J Proportion of commercial bills 0.317460317 W2=D/J Proportion of Bank Overdraft 0.158730159 W3=G/J Proportion of Bond 0.523809524 Cd=W1*C+W2*F+W3*I Average cost of debt on market value 4.34% Average cost of Equity on market value Preference Shares Number of Preference shares 20,000 (200000/10) Face value of each share 10 K Market value of preference shares 300,000 (20000*15) Semi annual dividends per share 0.5 (10*0.1)/2 Number of semiannual period to maturity 6 Semiannual yield to maturity -2.59% (Using Rate function of excelwith Nper=6, Pmt=0.5, PV=-15,FV=10) Annualyield tomaturity -5.19% L Cost of Preference shares -5.19% M Market value of Ordinary shares 1,200,000 (60000*20) D1 Dividend in next year 2.5 P0 Market Price per share 20 R=D1/P0 Required Return 12.50% N Cost of ordinary shares 12.50% Q=K+M Total Equity component market Value 1,500,000 W4=K/Q Proportion of Preference shares in equity 0.2 W5=M/Q Proportion of Common shares in equity 0.8 Ce=W4*L+W5*N Average Cost of Equity on market value 8.96% Average Cost of funds on market value S=J+Q Totalfunds on market value 2,130,000 Wd=J/S Weight of debt on market value of funds 0.295774648 We=Q/s Weight of Equity on market value of funds 0.704225352 Cf=Wd*Cd+We*Ce Average Cost of funds on market value 7.59%
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