Cost of capital and the discount rate

Melrose Kitchens plc has paid the dividends per share shown in the table. The 20X5 dividend has just been paid, and the share price is now £3.20 ex dividend. The directors expect dividends to keep growing at the same average annual rate as over the last four years.

Nairn Electrical plc's ordinary shares have an estimated beta of 1.3. The return on short-dated government bonds, taken as the risk-free rate, is 3.5% a year, and the expected return on the market portfolio is 8.5% a year.

Oban Marine plc has 6% irredeemable debentures, quoted at £92 per £100 nominal ex interest, and 7% preference shares of £1 each, quoted at 85p ex dividend. Assume corporation tax is 25%, debenture interest is fully deductible for tax, and preference dividends are paid out of post-tax profits with no tax relief.

Tarbet Logistics plc, a road haulage company, is considering a ten-year investment in a solar farm. The project would cost £30m now and produce after-tax cash flows of £4.5m a year at the end of each of the next ten years. Tarbet's current WACC is 7.5% a year. A quoted company that operates only solar farms has an equity beta of 1.35 and gearing (debt : equity at market values) of 30 : 70. Tarbet's gearing is 20 : 80 at market values, and it would finance the project so as to keep this gearing. Tarbet can borrow at 6% a year before tax. The risk-free rate is 3.5% a year and the expected return on the market is 9% a year. Corporation tax is 25%, and debt may be assumed to have a beta of zero.

Peebles Utilities plc has 5% loan stock that will be redeemed in four years' time at £105 per £100 nominal. Interest is paid annually in arrears, and the next payment is due in one year. The loan stock is quoted at £96.50 per £100 nominal ex interest. Assume corporation tax is 25%, tax relief on interest is received at the same time as the interest is paid, and no tax relief is available on the redemption premium.

The table shows the long-term finance section of Rosyth Components plc's statement of financial position. The ordinary shares are quoted at £4.20 ex dividend and have an equity beta of 1.2. The risk-free rate is 4% a year and the market risk premium is 6% a year. The preference shares are quoted at 80p ex dividend. The debentures are irredeemable and quoted at £104 per £100 nominal ex interest. Corporation tax is 25%, debenture interest is fully tax deductible and preference dividends are not.

Stanley Foods plc, a food retailer, plans to open a chain of bowling centres. Its own equity beta reflects food retailing, so it has found a quoted company, Tolsta Leisure plc, that operates only bowling centres. Tolsta's equity beta is 1.5 and its gearing (debt : equity at market values) is 40 : 60. Stanley's gearing is 25 : 75 at market values, and it would finance the project in this proportion. Stanley can borrow at 6% a year before tax. The risk-free rate is 4% a year and the market risk premium is 5% a year. Corporation tax is 25%, and the debt of both companies may be taken to have a beta of zero.

Uist Chemicals plc is financed entirely by equity and its cost of equity is 9% a year. It is considering a biotechnology project with an internal rate of return of 10.5%. A quoted company that operates only in biotechnology and is also financed entirely by equity has an equity beta of 1.6. The risk-free rate is 4% a year and the market risk premium is 5% a year.

Ythan Retail plc's equity has a market value of £60m and a cost of 12% a year. Its debt has a market value of £40m and a pre-tax cost of 7% a year. Corporation tax is 25%. A divisional manager proposes a £10m store refurbishment to be financed entirely by a new bank loan at 7%, and suggests appraising it at the post-tax cost of that loan, 5.25%. The refurbishment has the same business risk as Ythan's existing operations.

Wick Engineering plc has 20 million ordinary shares quoted at £2.50 ex dividend. It has just paid a dividend of 15p a share. It retains 40% of its earnings each year and expects to continue earning a return of 15% on the funds it reinvests. Wick also has £30m nominal of 4% loan stock, redeemable at par in five years' time, quoted at £93 per £100 nominal ex interest, with interest paid annually in arrears; and an £8m bank loan at a fixed rate of 6% a year, whose market value may be taken as equal to its book value. Corporation tax is 30% and interest is fully deductible, with relief received when the interest is paid.

Vatersay Group plc has two divisions. Its ordinary shares have an equity beta of 1.2, and its gearing (debt : equity at market values) is 1 : 3. Its debt is treated as risk-free, with a pre-tax cost equal to the risk-free rate of 3% a year. The market risk premium is 6% a year and corporation tax is 25%. Division A accounts for 60% of the market value of the group's assets and has an estimated asset beta of 0.8. Division B accounts for the rest. Vatersay currently uses its group WACC to appraise projects in both divisions.