Da Silva plc’s shares are not traded in any recognised market. Its sole activity is saloon car hire. It is financed by a combination of 2 million £0.50 ordinary shares and a £1.5 million bank loan. Very recently, Mavis plc, a national car hire group, offered a total of £5.5 million to acquire the entire equity of Da Silva plc. The bid failed because the majority of shareholders rejected it since they wished to retain control of the business, despite believing the offer to represent a fair price for the shares. The bank loan is at a floating rate of interest, currently at 10 per cent p.a., and is secured on various fixed assets. The value of the bank loan is considered to be very close to its nominal value.

Da Silva plc’s current capital structure (by market value) represents what has been, and is intended to continue to be, its target capital structure.

Da Silva plc’s management is in the process of assessing a major investment, to be financed from retained earnings, in some new depots, similar to the business’s existing ones. An appropriate cost of capital figure is required for this purpose. The Gordon growth model has been proposed as a suitable basis for the estimation of the cost of equity.

Recent annual dividends per share have been:

The business’s rate of corporation tax is expected to be 20 per cent for the foreseeable future.

(a) Estimate Da Silva plc’s weighted average cost of capital (WACC). (Ignore inflation.)

(b) What assumptions are being made in using the WACC figure that you have estimated as the basis for the discount rate?

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