Task 1

Weighted average cost of capital

• Average rate of return a company
• Cost of each capital component multiplied by its proportional weight
• WACC= (E/V)*Re + (D/V)*Rd * (1-Tc)
• Most important figures in assessing a company’s financial health
• internal use and external use

Uses of WACC

• Gives companies an insight into the cost of their financing
• Used as a hurdle rate for investment decisions
• Measure to find the best capital structure for the company
• Rough guide to the rate of interest per monetary unit of capital
• Provide a discount rate for cash flows with similar risk

WACC calculation

• WACC=( Rm70m/Rm120) x 11.25% +( Rm50m/Rm120) x 5% x (1-30%)
• 8.02% = 8%
• Expected return of 10% after tax = 2 cents of value per dollar invested
• Expected return of 12% after tax = 4 cents of value per dollar invested

WACC interpretation

• A return that is lower than WACC
• Company not shedding value 
• Lower WACC, lower the return required from providers of capital
• Lower return needed for projects to be undertaken to make it feasible
• Used dividend discounted model and not CAPM

Task 2

Task 3

Advantages

Stable debt management

• Detailed in formal contracts
• Installments are normally at a fixed rate 
• More security when budgeting for costs and expenses

Cost reduction advantages

• Interest on debt is tax deductible
• Lowers tax liability every year
• Long-term financing is regular and structured
• Require minimal maintenance
• Reduces the work hours required to maintain the loan

Flexibility

• Huge variety of long term loans available
• Able fine-tuned to meet the borrower's needs
• Better control over spending
• Useful when dealing with assets that have a predictable lifespan

Control

• Debt providers do not have any ownership over the business 
• Best interest of company as a whole 
• Profit of the company is not shared
• Only responsible to pay its loan payments in a timely manner
• No information required to be provided

Disadvantages

Fixed payment terms

• Money borrow must be paid back within a fixed period 
• Fixed rate and legally liable to pay interest on debt 
• Fixed maturity date required to make provisions
• Failing to do so : bankruptcy 

Cash flow problems and stunts growth

• Borrowing against future earnings
• Allocate a portion to debt payments instead of growth
• Overuse of debt limit CF and stunt growth
• CF problems during hard times faced by comopany

Collateral and Guarantees

• As lender's security to provide financial assistence  
• Risky move 
• Exposes the company’s property and assets
• Repossession by the bank

High risk reputation

• Debt increases the perceived risk associated with business
• Unattractive to investors
• Reduce the ability to raise additional capital in the future
• High loan = High gearing

Task 4