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Summary ManAcc: A1S2 notes

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ManAcc 278 notes: Cost of capital, Sources of Finance, Job costing, Process costing, Risk management

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  • August 31, 2020
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  • 2019/2020
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lexishtein
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)

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