A) Create a capital structure for the company

Solar transition is a company that deals with solar products such as solar lanterns, solar water

heaters and solar power backup products. The sources of finance for this company are mostly

long term. However the company choses to have a mixture of both long and short term sources

of finance. The long term sources include equity, retained earnings, preference shares and

debentures while the short term include loans and overdrafts. The current capital structure is:

Ordinary shares of sh10 each 5000000

Retained earnings 2000000

10% preference shares of sh10 each 1500000

14% debenture of sh.100 4000000

Bank overdraft at 12% 500000

The dividends rate grows at 8% per annum and the current dividend is sh.2 per share. The market

price of the share is sh.50. the tax rate of the company is set at 30% and the company pays this

annually. The preference shares have a market value of sh.20 each. Debentures have a 5 year

maturity period and their current market value is sh.90 each.

b) find the cost of capital for the company

The cost of capital will be:

Cost of equity

Ke=(do(1+g)+g)/Po) *100
do= sh.2

g=0.08

Po=sh.50

=(2(1+0.08)+0.08)/50)*100% = 4.48%

Cost of retained earnings

It is the same as that of equity. Therefore it is 4.48% as well.

Cost of preference shares

Kp=dp/Pp * 100%

dp= sh.20* 10% =2

Pp=20

Kp= 2/20 *100%

=10%

Cost of debentures

Kd= (int(1-T) + (M-Vd)1/n)/ (M+Vd)1/2 * 100%

Int=14%

T=30%

M=sh.100

Vd= sh.90
N=5

= 12.42%

Cost of overdraft

Kd=INT(1-T)/Vd *100%

INT= 12% * 500000= 60000

T=30%

Vd=500000

= 8.4%

Source of finance amount After tax cost Cost of capital

Ordinary shares 5000000 4.48% 224000
Retained earnings 2000000 4.48% 89600
Preference shares 1500000 10% 150000
debentures 4000000 12.42% 496800
overdraft 500000 8.4% 42000
total 16000000 1002400

WACC= 1002400/16000000 *100

=6.25%

c) use the cost of capital to make an investment appraisal which should have an element of

abandonment value and risk

solar transition would like to take up a project, project X with the following estimates. Project X

assumes a cost of capital of 10% and the amount invested at the beginning is sh.500000:

years Net Cashflows Abandonment Value

1 150000 280000
2 200000 240000
3 250000 180000
4 300000

If we abandon in the first year

500000-((150000*0.909) + (0.909*280000))

=sh.109130

In the second year

500000-((150000*0.909) + (200000*0.826) + (240000*0.826))

=sh.210

In the third year

500000-((150000*0.909) + (200000*0.826) + (250000*0.751) + (180000*0.751)

= -124480

The business should use the asset till the very last year because this is when the NPV is at its

highest.