Question 3
Delta Ltd wishes to calculate its current cost of capital for use as a discount rate in investment appraisal. The following financial information relates to Delta Ltd:
Financial Position statement extracts as of 31 December 2022
cta_question_2
The ordinary shares of Delta Ltd have an ex-div market value of £4.70 per share and an ordinary dividend of £0.36 per share has just been paid. Ordinary dividends are expected to grow in the future by 4% per year.
The preference shares of Delta Ltd are not redeemable and have an ex-div market value of £0.40 per share.
The 7% bonds are redeemable at a 5% premium to their nominal value of £100 per bond and have an ex-interest market value of £104.50 per bond.
The bank loan has a variable interest rate that has averaged 4% per year in recent years.
Delta Ltd pays profit tax at an annual rate of 19% per year.
Required:
a) Calculate the market value Weighted Average Cost of Capital (WACC) of Delta Ltd.
b) Discuss the pros and cons of using the WACC as a discount rate to evaluate capital budgeting projects.
c) Explain the impact of tax on the WACC according to the modified Modigliani & Miller (M&M II, 1963) capital structure model.
cta_question_1