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Week 7 Tutorial Questions 1

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Week 7 Tutorial Questions 1.2 Question 1 Burse Co wishes to calculate its weighted average cost of capital and the following information relates to the company at the current time: Number of ordinary shares 20 million Book value of 7% convertible debt $29 million Book value of 8% bank loan $2 million Market price of ordinary shares $5-50 per share Market value of convertible debt $107-11 per $100 bond Equity beta of Burse Co Risk-free rate of return 4.7% Equity risk premium (Rm-Rf) 6.5% Rate of taxation 30% Burse Co expects share prices to rise in the future at an average rate of 6% per year. The convertible debt can be redeemed at par in eight years' time, or converted in six years' time into 15 shares of Burse Co per $100 bond. Required: (a) Calculate the weighted average cost of capital of Burse Co. (12 marks) (b) Discuss the circumstances under which the weighted average cost of capital can be used in investment appraisal. (6 marks) (c) Discuss whether the dividend growth model or the capital asset pricing model offers the better estimate of the cost of equity of a company. (7 marks)