Question 3c
Recent financial information relating to Close Co, a stock market listed company, is as follows.
| $m | ||
| profit after tax (earnings) | 66.6 | |
| dividends | 40.0 | |
| statement of financial position information | ||
| $m | $m | |
| non current assets | 595 | |
| current assets | 125 | |
| ------- | ||
| total assets | 720 | |
| ------- | ||
| current liabilities | 70 | |
| equity | ||
| ordinary shares ($1 nominal) | 80 | |
| reserves | 410 | |
| ------- | ||
| 490 | ||
| non current liabilities | ||
| 6% bank loan | 40 | |
| 8% bonds ($100 nominal) | 120 | |
| ------- | ||
| 160 | ||
| ------- | ||
| 720 | ||
| ------- |
Financial analysts have forecast that the dividends of Close Co will grow in the future at a rate of 4% per year. This is slightly less than the forecast growth rate of the profit after tax (earnings) of the company, which is 5% per year.
The finance director of Close Co thinks that, considering the risk associated with expected earnings growth, an earnings yield of 11% per year can be used for valuation purposes.
Close Co has a cost of equity of 10% per year and a before-tax cost of debt of 7% per year. The 8% bonds will be redeemed at nominal value in six years’ time. Close Co pays tax at an annual rate of 30% per year and the ex-dividend share price of the company is $8·50 per share.
Required:
Calculate the weighted average after-tax cost of capital of Close Co using market values where appropriate.