Question 1 [15 marks]

Catalan Ltd is a small Cape Town-based company that records and sells CDs and DVDs featuring African musicians/artists and promotes their concerts all around the world. Catalan Ltd has 12 million shares outstanding, which are currently trading at twice their book value, and its debt is composed of 12% coupon-bearing BBB-rated bonds, which were issued 5 years ago and will mature on 30 June 2021. Typical BBB-rated bonds are currently yielding 10% in the market and the long-term government bond rate is 7.4%. Catalan derives 75% of its total market value from its CD/DVD production business and 25% from its concert promotion business. The company's most recent income statements and balance sheets are presented in Exhibits 1 and 2, respectively. Because of the tight ownership of the company and insufficient price data, estimating the cost of equity for the company is quite problematic. As a result, management makes use of comparable firms in the same lines of business. Relevant information on these comparables has been provided in Exhibit 3. The typical marginal tax rate for firms in these businesses is 28%. Assume a market risk premium of 5.5%.

a. Estimate the market value of the debt. [3 marks]

b. Estimate the current cost of equity. [5 marks]

c. Estimate the current weighted average cost of capital. [2 marks]

d. Explain how the cost of capital would change if the government bond rate were to increase from its current level to say 9%. [Hint: No need to recalculate the WACC. Only explain which variables in the WACC calculation will be affected and how.] [5 marks]

Exhibit 1: Catalan Ltd: Historical Income Statements, June 30 (R' million)

	2019		2020
Revenues	100		158
- Cost of Goods Sold	40		60
- Depreciation & Amortization	10		13
Profit before interest and taxes	50		85
Interest Expenses	5		5
Profit before tax	45		80
Taxation @ 28%	12.6		22.4
Net Profit after tax	32.4		57.6

Exhibit 2: Catalan Ltd: Historical Balance Sheet, June 30, 2020 (R' million)

		2020
Assets
Property, Plant & Equipment		100
Land and Buildings		50
Current Assets		50
Total		200
Liabilities
Current Liabilities		20
Debt		60
Equity		120
Total		200

Exhibit 3: Comparable Firms

Business	Average Beta(levered)		Average D/E Ratio
CD/DVD Business	1.15		50.00%
Concert Business	1.20		10.00%