Question 2c
Examiners Report

Candidates were asked here to calculate the weighted average cost of capital (WACC) using a cost of equity of 12%. Many candidates gained full marks here.

Since the cost of equity was provided, it did not need to be calculated, although some candidates wasted time in the examination doing this. The cost of debt of the bonds could be calculated using linear interpolation.

Most candidates were able to do this successfully, although some candidates used the market value as the redemption value and vice versa. Some candidates calculated the cost of debt on the assumption that the bonds were irredeemable, but the question said the bonds were redeemable in five years’ time.

Almost all candidates calculated the market values of equity and debt correctly. Some candidates multiplied their after-tax cost of debt by (1 – T) when calculating the WACC, mistakenly including the tax effect twice.

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