$($a$)$ The summarized balance sheet of Traders Ltd$.$ shows:

Capital employed: Kwacha

K$1$ shares $1,000,000$

Retained earnings $5,000,000$

Book value of equity $6,000,000$

$5\%$ bonds $4,000,000$

$10,000,000$

Employment of capital:

Sundry assets $10,000,000$

Traders Ltd$.$s bonds are currently selling at K$62\mathrm{.}50$ per K$100$ par value. The shares

sell at K$1\mathrm{.}25,$ this price reflecting expectations that the next dividend will be K$0\mathrm{.}20$

per share and grow at an annual rate of $4\%$ thereafter.

Calculate the weighted average cost of capital for this company. $(9$ marks$)$

$($b$)$ You have been hired by ABC Company to assess their capital structure. You

have been provided with the most recent income statement and balance

sheet for the company

Income Statement

Revenues K $100$ million

$-$ Cost of Goods Sold K $60$ million

$($Includes depreciation of K $10$ million$)$

$=$ EBIT K $40$ million

$-$ Interest Expenses K $6$ million

$=$ Taxable Income K $34$ million

$-$ Taxes K $13\mathrm{.}6$ million

$=$ Net Income K $20\mathrm{.}4$ million

Balance Sheet

Assets Liabilities

Fixed Assets K $100$ million Current Liabilities K $20$ million

Current Assets K $40$ million Debt K $60$ million

Equity K $60$ million

The company had $10$ million shares outstanding trading at K$24$ per share. Nearly

$40\%$ of the outstanding stock is held by the founding family. You are also provided

with the following additional information

A regression of returns on the stock against a market index over the last $5$

years yields a beta of $0\mathrm{.}90,$ but ABC had no debt for the first four out of the

five years. Its debt ratio in the fifth year was similar to its current debt ratio.

The debt is $10-$year bank debt; however, based on its interest coverage ratio

the firm would be rated AA and carry a market interest rate of $10\%.$ The

treasury bond rate is $8\%$ and the market risk premium is $5\mathrm{.}5\%.$

$($i$)$ Estimate the current cost of equity for ABC Company. $(3$ marks$)$

$($iii$)$ Estimate the current weighted average cost of capital for ABC

Company $(6$ marks$)$

$($iv$)$ Assume now that ABC plans to double its debt ratio. The bond rating is

expected to drop to BBB$,$ with a market interest rate of $11\mathrm{.}5\%.$ Estimate

the new cost of capital. $(7$ marks$)$

$($Total: $25$ marks$)$