Exam CIMAPRA19-F03-1 Topic 2 Question 124 Discussion
Actual exam question for CIMA's CIMAPRA19-F03-1 exam
Question #: 124
Topic #: 2
Question #: 124
Topic #: 2
Company M is a geared company whose equity has a market value of $1,500 million and debt has a market value of S300 million. The company plans to issue $200 million of new shares and use the funds raised to pay off some of the debt Company M currently has a cost of equity of 13% and a WACC of 10% It pays corporate tax at the rate of
30% Company B, an ungeared company operating in the same business sector as Company M, has a cost of equity of 12% Assume Modigliani and Miller's theory of capital structure with tax applies Which calculation below shows the correct approach to calculating the new WACC following the planned changes in capital structure?
30% Company B, an ungeared company operating in the same business sector as Company M, has a cost of equity of 12% Assume Modigliani and Miller's theory of capital structure with tax applies Which calculation below shows the correct approach to calculating the new WACC following the planned changes in capital structure?
Suggested Answer: B Vote an answer
To get the new WACC using Modigliani & Miller with tax:Find the ungeared (asset) cost of capital, KuK_uKu.Company B is ungeared and in the same business, so its cost of equity = asset return:Ku=12%K_u
= 12\%Ku=12% Work out the new capital structure after the refinancing.Current equity = $1,500mCurrent debt = $300mNew equity issue = $200m (used to repay debt)New equity E1=1,500+200=1,700E_1 = 1,500 +
200 = 1,700E1=1,500+200=1,700New debt D1=300#200=100D_1 = 300 - 200 = 100D1=300#200=100Total value (using market values) V1=D1+E1=100+1,700=1,800V_1 = D_1 + E_1 = 100 + 1,700 = 1,800 V1=D1+E1=100+1,700=1,800.Apply MM with tax for WACC:WACC=Ku[1#TDV]\text{WACC} = K_u
\left[1 - T \frac{D}{V}\right]WACC=Ku[1#TVD] WACC1=12%[1#0.30×1001,800]\text{WACC}_1 = 12\%
\left[1 - 0.30 \times \frac{100}{1,800}\right]WACC1=12%[1#0.30×1,800100] This gives approximately:12%
×(1#0.0167)#12%×0.9833#11.8%12\% \times (1 - 0.0167) \approx 12\% \times 0.9833 \approx 11.8\%12%× (1#0.0167)#12%×0.9833#11.8% This matches option B: 11.8%=12%×[1#(0.30×100/1,800)]11.8\% = 12\%
\times [1 - (0.30 \times 100 / 1,800)]11.8%=12%×[1#(0.30×100/1,800)].
= 12\%Ku=12% Work out the new capital structure after the refinancing.Current equity = $1,500mCurrent debt = $300mNew equity issue = $200m (used to repay debt)New equity E1=1,500+200=1,700E_1 = 1,500 +
200 = 1,700E1=1,500+200=1,700New debt D1=300#200=100D_1 = 300 - 200 = 100D1=300#200=100Total value (using market values) V1=D1+E1=100+1,700=1,800V_1 = D_1 + E_1 = 100 + 1,700 = 1,800 V1=D1+E1=100+1,700=1,800.Apply MM with tax for WACC:WACC=Ku[1#TDV]\text{WACC} = K_u
\left[1 - T \frac{D}{V}\right]WACC=Ku[1#TVD] WACC1=12%[1#0.30×1001,800]\text{WACC}_1 = 12\%
\left[1 - 0.30 \times \frac{100}{1,800}\right]WACC1=12%[1#0.30×1,800100] This gives approximately:12%
×(1#0.0167)#12%×0.9833#11.8%12\% \times (1 - 0.0167) \approx 12\% \times 0.9833 \approx 11.8\%12%× (1#0.0167)#12%×0.9833#11.8% This matches option B: 11.8%=12%×[1#(0.30×100/1,800)]11.8\% = 12\%
\times [1 - (0.30 \times 100 / 1,800)]11.8%=12%×[1#(0.30×100/1,800)].
by Hubery at Dec 16, 2025, 01:32 PM
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