9 The statement of financial position of PPK Bhd provides th

9. The statement of financial position of PPK Bhd. provides the following information RM (m) RM (m) Equity Ordinary shares (RM1 nominal value) Reserves 25 15 40 Non-Current Liabilities: 7% Convertible bonds (RM100 nominal value) 5% Preference shares (RM1 nominal value) 20 30 Current Liabilities Trade payables 10 25 95 Overdraft Total Equity and Liabilities PPK has an equity beta of 1.2 and the ex-dividend market value of the company is RM125 million. The ex-interest MV of the convertible bonds is RM21 million and the ex-dividend market value of the preference share is RM6.25 million. The convertible bonds of PPK have a conversion ratio of 19 ordinary shares per bond. The conversion date and redemption date are both on the same date in five years\'time. The currency ordinary share price of PPK is expected to increase by 4% per year for the foreseeable future The overdraft has a variable interest rate which is currently 6% per year a to increase in the near future. The overdraf has not changed in size over the last financial year, although 1 year ago the overdraft interest rate was 4% per year. The company\'s bank will not allow the overdraft to increase from its current level nd PPK expects this The equity risk premium is 5% per year and the risk-free rate of return is 4% per year. PPK pays profit tax at annual rate of 30% per year Calculate the WACC of PPK with relevant assumptions.

Solution

The answer is as follows:

First we will calculate the different components of the capital structure based on the market price:

1.Cost of Equity =Risk-Free Rate of Return + Beta * (Market Rate of Return – Risk-free Rate of Return)

                       =.04 +1.2*(.05-.04)

                       =.052

                       =5.2%

2.Cost of Retained Earnings :The retained earnings will follow the same principle of calculation as cost of equity as the cost of Kr_{e   ^=5.2%}

3.Cost of Convertible Bonds:

    Conversion Ratio =number of shares for which one bond have been exchanged

                              =par/conversion price

                              =RM 100/RM19

                              =5.26 shares

                 Conversion Value

                                     =stock value of the convertible *conversion ratio

                                     =RM 21*5.26*(1.04)*(1-t)

                                     =RM 80 or 8%

4.Cost of Preference Shares(K_{p)    =Cost of ex dividend/MV of ex dividend}

                                                                  _{=.5/ 6.25}

                                                                  _=8%

_{The following is the assumption:}

_{Since in the case of calculation of WACC we are usually looking at the long term WACC average cost of capital.So in this case we assume that the overdraft is 1 year old which is short term .So we are not including it in the calculation of WACC.}

_{Weighted Average Cost of Capital is calculated as follows:}

_{Sources of Capital                                            Cost of Capital                             Proportion of Total                       Weighted Cost of Capital}

_{Equity Share Capital                                            5.2%                                             125/167.25                                  3.88}

_{Retained Earnings                                               5.2%                                              15/167.25                                   .47}

_{Convertible Bonds                                               8%                                                 21/167.25                                  1.00}

_{Preference Shares                                              8%                                                6.25/167.25                                .3}

                                                                                                                                  _{WACC                                          5.65}