Question 2 20 Marks

Mango has no debt, and its cost of equity is 14 percent. It can borrow at 8 percent. The corporate tax rate is 40 percent.

Required:

2.1. Calculate the cost of equity and the weighted average cost of capital (WACC) of Mango if it decides to borrow up to the equivalent of 25, 50, 75, or 100 percent of its current equity. The proceeds would be used to buy back shares of the company. (12)

2.2. Draw a graph showing how Mangos cost of equity, cost of debt, and WACC vary with the debt-to-equity ratio. (4)

2.3. On the basis of your results, would you recommend that Mango change its capital structure? (4)

Question 3 20 Marks

Maskoot is a privately held company. John Dee, its owner-manager, has been approached by Juslaw. for a possible acquisition. The company has no debt.

What is the minimum price John Dee should ask, given the following information about his company?

• Sales, currently at R500 million, are expected to grow by 6 percent for the next three years, and then by 4 percent in perpetuity
• The operating margin before tax is expected to remain at 20 percent of sales
• Annual capital expenditure is expected to be equal to the depreciation expense of the year
• The working capital requirement would remain at 18 percent of sales
• The corporate tax rate is 40 percent
• John Dee requires a return of at least 10 percent for his family investment in the company

Question 4 10 Marks

The expected returns for securities A, B and C are listed below:

	Security A	Security B	Security C
Expected returns	12%	18%	9%

Assuming the risk-free rate of 3% and market premium of 6%:

4.1. What are the betas for the three securities? [4]

4.2. For a portfolio consisting of 20% of security A, 45% of security B, and 35%, determine the portfolios expected return and beta. [6]