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Royta Ltd, operates in the commercial painting industry
Royta Ltd, operates in the commercial painting industry. They have reluctantly come to the conclusion that some of their older equipment is reaching the end of its productive life and will need to be replaced sooner or later. They have asked for your assistance in determining their cost of capital in order to make this decision.
Capital Asset rode Their present capital structure is as follows: E =1.4 1 200 000 R2 ordinary shares now trading at R2,20 per share. 80 000 preference shares trading at R1.80 per share (issued at R2 per share). Interest at 10%p.a. A bank loan of R 1 000 000 at 10.5% p.a. (payable in 3 years time) Additional data 8 a. The company's beta is 1.4. A return on market of 12% is accepted and a risk free rate of 7% is applicable. b. The current tax rate is 30% C. The company's current dividend is 43c per share and they expect their dividends to grow by 7% p.a. RE -? Required: priang 4.1 Assuming that the company uses the CAPM to calculate its cost of equity. Calculate its weighted average cost of capital. WACC = [CD/DXROCI-ig + E/Vynixke 4.2 A further R800 000 is needed to finance the expansion. Which option should they use (from ordinary shares, preference shares or loan financing)? Provide a reason for your answer. (3) referencer has
Expert Solution
Answer : 4.1) Calculation of Weighted Average Cost of Capital :
WACC = (Cost of After tax Debt * Weight of Debt) + (Cost of Preference shares * Weight of preference shares) + ( Cost of Equity * Weight of Equity)
Calculation of Cost of Equity and After-Tax Cost of Debt of the firm
Cost of Equity = Risk free rate + Beta * ( Expected market return - Risk free return)
= 7% + 1.4 * (12% - 7%)
= 7% + 7%
= 14%
Cost Of Presence share = Dividend / Current Price
= (2 * 0.10) / 1.80
= 11.11%
After-Tax Cost of Debt of the firm = Interest Rate * (1 - tax rate)
= 10.5% * (1 - 0.30)
= 7.35%
Calculation of Weight of Equity and Debt of the firm :
Market Value of Equity = Number of Equity shares * Price per share
= 1,200,000 * 2.20
= 2,640,000
Value of Debt = 1,000,000
Value of Preference shares = 80000 * 1.80
= 144,000
Total Market Value = 2,640,000 + 1,000,000 + 144,000
= 3,784,000
Calculation of WACC of the Firm
WACC = (Cost of After tax Debt * Weight of Debt) + ( Cost of Equity * Weight of Equity)
= [7.35% * (1,000,000 / 3,784,000)] + [11.11% * (144,000 / 3784000)] + [ (14% * (2,640,000 / 3784000)]
= 1.94% + 0.42% + 9.77%
= 12.13%
4.2) For expansion the company should choose loan financing as it has lowest cost.
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