- 20 Marks
FM – Nov 2023 – L2 – Q1 – Cost of capital | Economic and regulatory environment
Distinguish between expansionary and contractionary monetary policies, discuss the impact of raising the monetary policy rate, and calculate the cost of equity and WACC for Moli Ltd.
Question
a) Monetary policies are seen either as expansionary or contractionary depending on the level of growth within the economy. The Bank of Ghana, which is responsible for pursuing sound monetary policies, has recently raised the monetary policy rate by 150 basis points.
Required:
i) In reference to the statement above, distinguish between expansionary monetary policy and contractionary monetary policy. (4 marks)
ii) Would you describe the raise in the monetary policy rate as an expansionary or contractionary monetary policy action? Explain. (2 marks)
iii) Explain TWO (2) implications of raising the monetary policy rate for the financial performance of businesses. (4 marks)
b) Moli Ltd is financed by a mixture of equity and debt capital in the ratio of 2:1. The pre-tax cost of debt is 25% whilst the risk-free interest rate is 15%. The available market information puts the average stock market return on equity at 22%. The equity beta value of Moli Ltd has been estimated as 0.9. The corporate tax rate is 30%.
Required:
i) Calculate the cost of equity. (4 marks)
ii) Calculate the weighted average cost of capital. (6 marks)
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