Candidates were asked here to calculate the market value weighted average cost of capital (WACC) of a company. Most candidates did well on this question.

As the question asked for market values to be used, no marks were given to using book values as weights. Most candidates calculated market values correctly for ordinary shares, preference shares and bonds, although some candidates forgot that the bond market price related to a nominal value per bond of $100.

Some candidates incorrectly omitted the long-term bank loan from the WACC calculation. Although the bank loan had no market value, its book value could be used instead and due to its significance as a long-term source of finance in this case, it had to be included in the WACC calculation.

The historical dividend growth rate needed to be calculated for use in the dividend growth model (DGM) and some candidates had difficulty here, using either the wrong dividend or the wrong base period. Most candidates were able to calculate the cost of equity using the DGM and where this was not the case, a lack of understanding was usually in evidence.

Most candidates calculated the cost of preference shares correctly, although some candidates lost marks by making it an after-tax value. Since preference shares pay a dividend, which is a distribution of after-tax profit, there is no tax effect to consider.

Most candidates calculated the cost of debt of the bonds either correctly or reasonably well. Errors that were made in the internal rate of return calculation included:

• Redemption at nominal value rather than at a 5% premium to nominal value. 
• Using nominal value as the purchase price of the bond rather than market value. 
• Treating the purchase price as income and interest and redemption value as expenditure. 
• Using the before-tax interest payment in the calculation instead of the after-tax interest payment. 
• Interpolating when the calculated net present values called for extrapolation.

Some candidates used the before-tax interest rate on the bank loan as its cost of debt, when the after-tax interest rate should have been used. Alternatively (with explanation), the after-tax cost of debt of the bonds could have been used as the cost of debt of the bank loan.