Tailoka is a large company with gearing debt to equity ratio by market values of 1:2.Thecompany’s profit after tax in the most recent year were K2,700,000 of which K1,070,000was distributed as ordinary dividends. The Company has 5 million issued ordinaryshares which are currently trading on the LUSE at K3.21.Corporate tax rate is 35% andcorporate debt is risk free. Tailoka would want to undertake a new capital project. Theproject is a major diversification into a new industry. You have been tasked to provideestimates of the discount rate to be used in evaluating this new investment.

You have been given the following information showing estimates for the next five years.

Growth rate of own company earnings	12%
Average Equity Beta coefficient	1.5
Average industry gearing (debt to equity) ratio	1:3 by market value
Average payout ratio	55%
Stock market total return on equity	16%
Growth rate of own company dividends	11%
Growth rate of own company sales	13%
Treasury bills	12%
Own company dividend yield	7%
Own company geared equity beta	1.4
Own company share price rise	14%

Required

(a) Calculate the company’s weighted Average Cost of Capital (WACC) using theCapital Asset Pricing Model (CAPM).

(b) Calculate the company’s weighted Average Cost of Capital (WACC) using thedividend valuation model.

(c) Describe the situations under which the above two models will produce samevalues for WACC.

(d) Discuss any five (5) practical problems of using CAPM in investmentappraisal.|

(e) Prepare a brief report recommending which discount rate you should use for thisinvestment. Information from pars (a),(b) and (c) above may be useful.

Answer rating: 100% (QA)

Solution aCompanys weighted Average Cost of Capital WACC using CAPM Cost of Equity RFRBetaMarket returnRFR ie12151612 18 Aftertax Cost of the riskfree ... View the full answer