Case Scenario:
The Pauncefort Group is active in a number of different industrial sectors, particularly Engineering. Quentin plc is the group holding company. The Board of Directors of Quentin plc are actively considering a number of projects that might be undertaken by the company or one of its subsidiaries. As a matter of policy, the Board appraises the viability of projects using a discounted cash flow approach.
Quentin plc has 12 million ordinary shares of 50p each in issue out of an authorised ordinary share capital of 15 million. The company has recently paid a dividend of 11p per share on the ordinary shares, which are currently listed at 111p ex div. The dividend growth rate has recently been a little under 11% p.a., and this is expected to continue for the foreseeable future. Extracts from the group balance sheet are as follows:
Quentin plc
£000
Ordinary shares 6,000
Share premium 4,920
Reserves 7,590
Minority interests 1,590
3% irredeemable debentures 4,000
6% redeemable debentures 5,000
Interest on the debentures is payable annually, and both of the current year's payments are impending. The current market prices for £100 nominal value stock are £33.50 and £105.50 for the 3% and 6% debentures, respectively (both values being cum interest). The 6% debentures are redeemable in ten years' time at a premium of 2.5%. The effective corporation tax rate for Quentin plc is 35%.
Required:
Calculate the weighted average cost of capital to be used by the company in appraising the viability of its projects, explaining and justifying the approach, and commenting on the results.