Page 31 - CIMA MCS Workbook February 2019 - Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

not been provided. Note that the combined total of share capital and share premium increased by
V$6.0m to V$47.287m in 2018.

WACC
A weighted average cost of capital would be calculated by taking an average of the cost of debt
and the cost of equity, using the market values of the debt & equity finance as the relative
weightings.

Calculation of WACC ‐ Smilebrite

Cost of debt
Effective interest rate (per exercise 1) is 8% for both 2018 and 2017.
Effective tax rate is 29% in both 2018 and 2017 (to nearest %).

Based upon 2017, the post‐tax cost of debt is therefore in the region of 8.0% x (1‐0.29) = 5.68%,
for both years, assuming that debt is long‐dated or irredeemable. Note that this will be affected
by the increase in loan‐term loans during 2018.

Cost of equity

It is not possible to calculate the cost of equity as the share price of Smilebrite is not provided – it
is an unlisted company. Also, the breakdown between issued share capital and share premium has
not been provided. Note that the combined total of share capital and share premium was
unchanged at V$2.6m throughout 2018.

WACC
A weighted average cost of capital would be calculated by taking an average of the cost of debt
and the cost of equity, using the market values of the debt & equity finance as the relative
weightings.

For both Crowncare and Smilebrite, as the cost of equity cannot be calculated from the available
information, it is not possible to calculate the WACC.

Given that part of Crowncare’s strategy is to acquire complementary businesses, this is an
important consideration when dealing with investment appraisal decisions.
However, it is only appropriate to use WACC when the following conditions are met:
 The capital structure is constant, since if this changes, the weightings in the WACC
calculation would also need to change. Note that, during 2018, there was an issue of shares
by Crowncare.
 The new investment does not have a different risk profile to the existing entity’s investment
projects. This could be the case if Crowncare invests only other, similar dental practices.
 The new investment is marginal to the entity. Any substantial new investment is likely to
result in a change to the WACC.

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