Question

Practice Question: Cost of Capital
Question One:
On my Own PLC has the following capital structure in 2006:
£’ 000

1m Ordinary shares of £1 each 1,000

400,000 Preference shares of 50p each 200

7% Redeemable Debentures (£1 each) 200
Total 1,400
Additional Notes:
1. The ordinary shares have a current market value of £1.20 per share, and a dividend
of 6p per share has just been paid. Dividend growth is expected to be at a rate of
12% per year.
2. The preference shares have a current market value of 60p per share and the rate of
dividend is 8%.
3.
The redeemable debentures have a coupon rate of 7% and a current market price
of £94 per £100 block. These are redeemable in 8 years time.
4. Corporation tax rate is to be taken as 30%
Required:
(a) Calculate the weighted average cost of capital for On my Own PLC using market
values (12 marks)
(b) Explain why it is considered preferable to use market values rather than
book values when making this calculation. (4 marks)
(c) Discuss the importance of gearing to a potential investor in some ordinary
shares in On my Own PLC. (4 marks)
(Total 20 marks)