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COST OF CAPITAL
COST OF CAPITAL (WEIGHTED AVERAGE COST
OF CAPITAL)
The Cost of Capital under this case study refers to the
Weighted Average Cost Of Capital
=2.09 + (12.0-2.09)*0.74
=9.4234
Cost of debt refers to the effective rate a company pays on its current
debt. In most cases, this phrase refers to after-tax cost of debt, but it
also refers to a company's cost of debt before taking taxes into
account. The difference in cost of debt before and after taxes lies in
the fact that interest expenses are deductible.
In arriving at the cost of debt 2 methods are worth
mentioning:
1. The Yield-to-maturity approach &
2. Debt rating approach
The following assumptions were used in arriving at
the cost of debt
F=US$550M
P=550*0.99175=545.4625
C=2%*550=11
n=5yrs
YTM=[ C + (F-P/n)/ F+P/2]
=11 + (550-545.4625/5)/550+545.4625/2
=11.9075/547.73125=2.174%
Introducing tax of 16.5%
=0.002174(1-0.165)
=1.8153%
Using the Yield to maturity and the Long Term Bond of
debt MTRC is realising a cost of debt of 1.8153%
Using the debt rating approach
The Yield on an AAA debt for MTR Corporation for bonds with
maturity period of April 2017 had a Yield of 1.99% per Schedule
Exhibit 8.
Hence the debt rating approach cost of debt would be
0.0199(1-0.165)
1.6616%
Capital Structure Schedule
Looking at only Looking at all long term
market value of bond debt and short term
debt debt
=176686.5/177236.5*9.4234 + 550/177236.5*1.8153
=9.39+0.0056
=9.3956%
The WACC when just the Bond Loan amounts are used
is 9.3956%, the reason for such assumption is because
it is assumed by the time projects needed for the
assessment with the cost of capital all short term debts
would be non-existent.
How should MTRC employ its cost of capital