Question 1: Cost of Capital (8 marks)
You are to estimate the cost of capital for Boral Ltd, an Australian listed company, at its half year ended (31 December 2014). Boral manufactures and supplies building and construction materials mainly in Australia but also in the USA and Asia. Boral uses both debt and equity financing.
Before you can undertake this task, you will need to collect some actual finance data. The ‘External Links’ section of this unit’s MySCU web site contains links to Internet sources of information that you might find useful for this assignment. Amongst other sources, you should consider Statistical Tables F2 (daily) and F3 (monthly) available through the RBA website.
In estimating the cost of capital, you can make the following assumptions:
Loans and borrowings on the Boral half-year (interim) balance sheet reflect market value.
All loans and borrowings can be classified as debt.
Gross debt, not net debt, is used to calculate the cost of capital.
Boral aims to maintain its current Baa long-term company credit rating.1 An average yield on 10-year corporate bonds with a rating equivalent to Moody’s Baa can therefore be used in this analysis.2
The CAPM is used to estimate the cost of ordinary equity.
The 10-year Australian Treasury bond rate is an appropriate proxy for the risk-free rate.
The beta for Boral is not expected to change in the near future.
The market risk premium is 6.4%.
Boral operates in a classical tax system. (Not true but we will assume so for simplicity.)
Boral’s tax rate is 30%.
Set out full workings in a clear and logical manner. Label all input figures and reference their source.
Marks for Question 1 will be awarded for: appropriate choice of input figures (up to 3.5 marks); correct choice and application of method (up to 4 marks); and referencing of data sources (up to 0.5 marks).