Scribd
Upload
16 views2 pages

Tutorial

GOSA plc is evaluating its long-term financial strategy, particularly the potential for borrowing to fund a $200m expansion, as it currently relies heavily on equity financing. The document outlines calculations for the company's weighted average cost of capital (WACC) and discusses the implications of using debt versus equity for financing. Additionally, it includes a proposal from the marketing director to enhance the company's appeal to investors to potentially lower the cost of capital.

Uploaded by

mashiringwaninyasha2003
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
16 views2 pages

Tutorial

GOSA plc is evaluating its long-term financial strategy, particularly the potential for borrowing to fund a $200m expansion, as it currently relies heavily on equity financing. The document outlines calculations for the company's weighted average cost of capital (WACC) and discusses the implications of using debt versus equity for financing. Additionally, it includes a proposal from the marketing director to enhance the company's appeal to investors to potentially lower the cost of capital.

Uploaded by

mashiringwaninyasha2003
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 2

Tutorial 1

GOSA plc is a quoted company. Its directors are reviewing the company’s long
term
financial strategy. The company has been criticised for being financed largely by
equity. It has no significant long term borrowings. The board has asked for some
calculations to enable them to decide whether the company should consider
borrowing in the future. The next phase of expansion will require the company to
raise $200m and will involve a general expansion of the existing lines of
business.
The following information has been obtained:
Current risk free rate 4%
Equity risk premium 5%
Current corporation tax rate 30%
Equity capital $1,000m
GOSA plc’s Beta 1.4
Probable gross interest rate on debt 7%
(i) Calculate GOSA plc’s expected weighted average cost of capital (WACC). [3]
(ii) Calculate GOSA plc’s expected WACC AFTER the new finance has been raised
assuming that the finance is raised by borrowing. [6]
(iii) Explain the relevance of the WACC figure to the decision to use equity or
debt
for the new finance. [6]

GOSA is a quoted company. The directors have asked for a report on the
company’s
cost of capital. The following information has been provided:
• The market capitalisation of the company’s equity is £600 million.
• The company has debentures with a face value of £250 million. Their market
value is £220 million.
• The corporation tax rate is 23%.
• The risk–free rate of interest is 4% per annum.
• The ungeared beta on GOSA’s equity is 1.3.
• The debentures have a coupon rate of 5% and are redeemable at par in five
years’
time.
• The market rate of return is 9% p.a.
The directors have already calculated GOSA’s weighted average cost of capital
(WACC), but they wish you to prepare a calculation in order to confirm their
figures.
They are concerned that the WACC is higher than they think is justified and they
wish to discuss some proposals for reducing the figure because the directors plan
to raise
further finance in order to fund expansion, but they are unwilling to do so if the
cost
of capital is overstated.
(i) Determine GOSA’s cost of equity using the company’s geared beta. [4]
(ii) Determine GOSA’s approximate cost of debt. [4]
(iii) Calculate GOSA’s WACC. [2]
The marketing director has suggested that the company could dramatically
reduce the
cost of capital if the board promotes the company in the same way that it
promotes its
products. The directors should identify the market’s needs and explain to those
who
provide finance just how well suited GOSA is to meeting those needs.
(iv) Discuss the logic of the marketing director’s proposal for reducing the WACC.
[10]

You might also like