BBMF2814 FINANCIAL MANAGEMENT 2 RAC
Week 7 Tutorial Questions
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Question 1
Burse Co wishes to calculate its weighted average cost of capital and the following information relates
to the company at the current time:
Number of ordinary shares 20 million
Book value of 7% convertible debt $29 million
Book value of 8% bank loan $2 million
Market price of ordinary shares $5·50 per share
Market value of convertible debt $107·11 per $100 bond
Equity beta of Burse Co 1·2
Risk-free rate of return 4·7%
Equity risk premium (Rm-Rf) 6·5%
Rate of taxation 30%
Burse Co expects share prices to rise in the future at an average rate of 6% per year. The convertible
debt can be redeemed at par in eight years’ time, or converted in six years’ time into 15 shares of
Burse Co per $100 bond.
Required:
(a) Calculate the weighted average cost of capital of Burse Co. (12 marks)
(b) Discuss the circumstances under which the weighted average cost of capital can be used in
investment appraisal. (6 marks)
(c) Discuss whether the dividend growth model or the capital asset pricing model offers the better
estimate of the cost of equity of a company. (7 marks)
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BBMF2814 FINANCIAL MANAGEMENT 2 RAC
Week 7 Tutorial Questions
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Question 2
British Malaysia Tobacco Berhad (BMT) is a multinational company that manufactures and sells
cigarettes, tobacco and other nicotine products. It is estimating its current weighted average cost of
capital as it plans to raise capital for its new projects.
Dividend and earnings per share of BMT for the past 5 years are as follows:
Year 2020 2019 2018 2017 2016
Dividend per share 10 sen 9 sen 8 sen 7 sen 6 sen
Earnings per share 30 sen 27 sen 24 sen 21 sen 18 sen
The current market price of the ordinary share of BMT is RM2.15 per share and the company has 5
million ordinary shares in issue.
BMT has issued a total of RM5 million, 7% irredeemable debenture with a par value of RM100 per
debenture. The current market price of the debenture is trading at RM120 and the interest is payable
annually.
BMT has also issued 300,000 preferred shares that pay an annual dividend per share of 88 sen and the
market price of the preferred share is RM10 per share.
Corporate tax is at a rate of 24%.
Required:
(a) Calculate the cost of equity using the dividend growth model. (4
marks)
(b) Calculate the cost of irredeemable debt. (3
marks)
(c) Calculate the cost of preferred shares. (2
marks)
(d) Calculate the weighted average cost of capital using the market value basis. (8
marks)
(e) Discuss the dividend policy adopted by BMT and ANY THREE (3) implications of the dividend
policy. (8
marks) [Total:
25 marks]
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BBMF2814 FINANCIAL MANAGEMENT 2 RAC
Week 7 Tutorial Questions
__________________________________________________________________________________
Question 3
“The optimal capital structure of a firm is often defined as the proportion of debt and equity that
result in the lowest weighted average cost of capital for the firm”.
Required:
Discuss the above statement based on the following theories. You are also required to explain the
impact of capital structure on the weighted average cost of capital and value of a firm under each of
these theories:
(i) Traditional theory; (4 marks)
(ii) Modigliani and Miller (with and without taxes); (4 marks)
(iii) Pecking order theory. (4 marks)
