Management Accounting
2020
Semester 2
278
by: Alexandra Shtein
, Table of Contents
COST OF CAPITAL ....................................................................................................................................................... 2
SOURCES OF FINANCE .............................................................................................................................................. 20
JOB COSTING ............................................................................................................................................................ 32
PROCESS COSTING ................................................................................................................................................... 46
RISK MANAGEMENT ................................................................................................................................................ 65
,COST OF CAPITAL
o Weighted average cost of capital:
• average cost a company needs to obtain a mixture of financing from various sources
• expressed as %
• need to calculate for project return, discounted cash flows, determination of fair value of assets for financial
reporting purposes
o Principles for calculation:
• use all permanent sources of finance
• marginal costs
• after tax effect
• nominal rates (versus real rate)
• target capital structure OR capital structure using market value
o Calculate the cost of capital (WACC):
• Calculate the marginal cost of every source of finance, including the effect of tax. Use nominal rates
• Calculate the weight of every component of financing (use target capital structure and if not available use market
values)
• Calculate the weighted average cost of capital (WACC)
∑Marginal cost x weight = WACC
determined based
on target capital
structure –
determine based
% cost not a on market value of multiply cost
rand amount each element by weight
,EXAMPLE:
Simplest form:
Company A:
• Market value of ordinary shares R2,000,000
• Cost of equity Ke 15%
• Market value of debentures R1,500,000
• Cost of debt (Before tax) 12%
• Tax rate 28%
• Market value of preference shares R1,000,000
• Cost of preference shares 10%
Calculate the weighted average cost of capital.
Market value of ordinary shares R2,000,000
Cost of equity Ke 15%
Market value of debentures R1,500,000
Cost of debt (Before tax) 12%
Tax rate 28%
Market value of preference shares R1,000,000
Cost of preference shares 10%
, o Usage of WACC (Weighted average cost of capital):
• to discount future cash flows
• to value a business / evaluate project accept or reject
• Base decisions on WACC
Capital structure works:
if make a profit / paying back debt – equity grows over time due to increased retained earnings
pay dividends: equity will drop
issue more debt – debt will increase
è RATIO WILL CHANGE
“Target ratio
only averaged
over time”
EXAMPLE:
Marginal cost of equity = 14%
Marginal cost of debt is 8%
Project 1, which will be financed from debt, delivers a return of 10%.
Project 2, which will be financed from equity, delivers a return of 12 %.
Which project(s) must we accept?
Assume we have a company with a target debt:equity ratio of 50:50
Component Cost Weight WACC
Equity 14% 50% 7%
Debt 8% 50% 4%
WACC 11%
Accept PROJECT 2 as return of 12% is higher than WACC of 11% (higher than average cost of financing)
2020
Semester 2
278
by: Alexandra Shtein
, Table of Contents
COST OF CAPITAL ....................................................................................................................................................... 2
SOURCES OF FINANCE .............................................................................................................................................. 20
JOB COSTING ............................................................................................................................................................ 32
PROCESS COSTING ................................................................................................................................................... 46
RISK MANAGEMENT ................................................................................................................................................ 65
,COST OF CAPITAL
o Weighted average cost of capital:
• average cost a company needs to obtain a mixture of financing from various sources
• expressed as %
• need to calculate for project return, discounted cash flows, determination of fair value of assets for financial
reporting purposes
o Principles for calculation:
• use all permanent sources of finance
• marginal costs
• after tax effect
• nominal rates (versus real rate)
• target capital structure OR capital structure using market value
o Calculate the cost of capital (WACC):
• Calculate the marginal cost of every source of finance, including the effect of tax. Use nominal rates
• Calculate the weight of every component of financing (use target capital structure and if not available use market
values)
• Calculate the weighted average cost of capital (WACC)
∑Marginal cost x weight = WACC
determined based
on target capital
structure –
determine based
% cost not a on market value of multiply cost
rand amount each element by weight
,EXAMPLE:
Simplest form:
Company A:
• Market value of ordinary shares R2,000,000
• Cost of equity Ke 15%
• Market value of debentures R1,500,000
• Cost of debt (Before tax) 12%
• Tax rate 28%
• Market value of preference shares R1,000,000
• Cost of preference shares 10%
Calculate the weighted average cost of capital.
Market value of ordinary shares R2,000,000
Cost of equity Ke 15%
Market value of debentures R1,500,000
Cost of debt (Before tax) 12%
Tax rate 28%
Market value of preference shares R1,000,000
Cost of preference shares 10%
, o Usage of WACC (Weighted average cost of capital):
• to discount future cash flows
• to value a business / evaluate project accept or reject
• Base decisions on WACC
Capital structure works:
if make a profit / paying back debt – equity grows over time due to increased retained earnings
pay dividends: equity will drop
issue more debt – debt will increase
è RATIO WILL CHANGE
“Target ratio
only averaged
over time”
EXAMPLE:
Marginal cost of equity = 14%
Marginal cost of debt is 8%
Project 1, which will be financed from debt, delivers a return of 10%.
Project 2, which will be financed from equity, delivers a return of 12 %.
Which project(s) must we accept?
Assume we have a company with a target debt:equity ratio of 50:50
Component Cost Weight WACC
Equity 14% 50% 7%
Debt 8% 50% 4%
WACC 11%
Accept PROJECT 2 as return of 12% is higher than WACC of 11% (higher than average cost of financing)
