You are the newly-appointed financial manager of Bull Ltd which is a listed company. The managing director has asked you to assess whether the company’s ordinary shares are correctly priced at present and to determine the company’s cost of capital. Based on your enquiries, you have ascertained the following:

The company’s expected returns, and their subjective probabilities assigned by leading securities brokers in various market conditions, are set out below:

Market condition	Probability of condition	Market returns (%)	Return on Barco’s Ordinary shares (%)
Very poor	0.10	–10	–20
Poor	0.20	5	–5
Average	0.40	20	30
Good	0.20	35	50
Very good	0.10	50	60

1. The projected risk-free rate is 10% per annum for the foreseeable future.
2. The company is in a tax-paying position, and its current tax rate is 35%.
3. The company’s present capital structure, which is considered optimal at current market values, is as follows:
• 1 000 000 ordinary shares in issue. The current share price is N$6.50
• 16% cumulative, redeemable preference shares at a total carrying amount of N$1 100 000. These shares are redeemable in five years’ time at the carrying amount and similar preference shares are trading at an 18% yield per annum. The current dividend has just been paid and you are confident that future dividends will be paid at the end of each year until redemption.
• 12% irredeemable debentures at a total carrying amount of N$3 750 000. The market interest rate for similar debentures is 15%.

Required
(a) Apply the capital asset pricing model (CAPM) to determine if the company’s ordinary shares are correctly priced at present.
(b) Determine the company’s current weighted average cost of capital.
(c) Explain why investors are concerned with the systematic rather than the total risk of a share, and explain how systematic risk is measured.

Answer rating: 100% (QA)

a Based on the information given the companys expected return is ER Rf ERM Rf ER 10 2... View the full answer