RAW BSC is a listed food retailor chain that has a capital structure of both debit and equity. The equity beta of RAW is BSC is 0.7 and the ex-dividend market value of each ordinary share is BHD 5.50 Currently, the company has 10 million ordinary shares. The company has BHD17 million 5% redeemable debentures, which will be redeemed in five years at a nominal value of BHD100 Coupon payments on the debentures have just been paid and the current market value of each debenture is BD109.14 percent.

RAW BSC is planning to expand its existing business operations into a new business area. A project of selling smart devices is currently under the management appraisal, however, the management is not quite sure of which cost of capital to use for discounting the project cash flows. RAW BSC s identified a company in the same business area as the project SmackDown BSC which has an equity beta of 1.7 and an equity market value of BHD 77 million. The market value of SmackDown BSC debt is BHD9 million.

The rate of return on government securities is 5 % annually and the stock market average return is 17 % annually. The corporate tax rate for both companies is 30 % annually

Required:

a) Find RAW BSC weighted average cost of capital before expansion.

b) Advice RAW BSC on the appropriate cost of equity to be used in appraising the new smart devices project.

c) Explain the difference between systematic and unsystematic risk in relation to portfolio theory and the capital asset pricing model (CAPM)

Answer rating: 100% (QA)

Quiz A RAW BSCs weighted average cost of capital before expansion is 1165 The company has 10 million ordinary shares and BHD17 million 5 redeemable debentures The equity beta of RAW BSC is 07 and the ... View the full answer