These are Questions and Answers on corporate finance and this is for bachelor of commerce in financial management students and anyone else who does the same module . There are summaries of concepts and aspects of this module included.
You have been appointed as a financial consultant by the directors of Chennai Holdings.
They require you to calculate the cost of capital of the company.
The following information is available on the capital structure of the company:
1 500 000 Ordinary shares (O/S) with a market price (MP) of R3 per share. The latest
dividend (D0) declared was 90 cents per share. A dividend growth (g) of 13% was
maintained for the past 5 years.
1 000 000 12%, R1 Preference shares (P/S) with a market value of R2 per share.
R1 000 000 9%, Debentures (D) due in 7 years and the current yield-to-maturity (YTM) is
10%.
R700 000 14% Bank loan (BL) , due in December 2025.
Additional information:
1. The company has a tax rate (Tc) of 30%.
2. The beta of the company is 1.6, a risk-free rate of 7% and the return on the market is
15%.
Required:
1.1 Calculate the weighted average cost of capital (WACC). Use the Gordon Growth Model
to calculate the cost of equity (Ke). (22 marks)
1.2 Calculate the cost of equity (Ke), using the Capital Asset Pricing Model (CAPM)
,COST OF CAPITAL
What is Cost of Capital?
Cost of capital is the minimum rate of return that a business must earn before generating
value. Before a business can turn a profit, it must at least generate sufficient income to
cover the cost of the capital it uses to fund its operations. This consists of both the cost of
debt and the cost of equity used for financing a business. A company’s cost of capital
depends, to a large extent, on the type of financing the company chooses to rely on – its
capital structure. The company may rely either solely on equity or solely on debt, or use a
combination of the two.
The choice of financing makes the cost of capital a crucial variable for every company, as it
will determine the company’s capital structure. Companies look for the optimal mix of
financing that provides adequate funding and minimizes the cost of capital.
STEP 1 – MARKET VALUE
O/S = NO. of O/S x MP per share = 1 500 000 x R3
= R4 500 000
P/S = NO. of P/S x MV per share = 1 000 000 x R2
= R2 000 000
D = (PV CAPITAL) + (PV INTEREST) = (R1 000 000 x PV FACTOR) + (R90 000 x PV
FACTOR)
CAPITAL PORTION = R1M … non – constant cash flow
table (table 1)…. YTM % = (R1 000 000 x 0.5132) + (R90 000 x 4.8684)
= 513 200 + 438 156
Interest portion = 9% = R951 356
= R1M x 9% = R90 000 … constant CF (TABLE 2)
…YTM%
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