IRM Ltd, operates in the commercial painting industry. They have reluctantly come to the conclusion that some of their older equipment is reaching the end of its productive life and will need to be replaced sooner or later. They have asked for your assistance in determining their cost of capital in order to make this decision. 

Their present capital structure is as follows:

800,000 R2 ordinary shares now trading at R2.50 per share, 250,000 preference shares trading at R2 per share (issued at R3 per share), 10% fixed rate of interest, a bank loan of R1500 000 a at 10.5% p.a. (payable in 3 years’ time)

Additional data 

a. The company’s beta is 1.4. A return on market of 12% is accepted and a risk free rate of 7% is applicable.

b. The current tax rate is 30%

c. The company’s current dividend is 43c per share and they expect their dividends to grow by 7% p.a.

Required:

1.1 Assuming that the company uses the CAPM to calculate its cost of equity. Calculate its weighted average cost of capital.

1.2 A further R800 000 is needed to finance the expansion. Which option should they use (from ordinary shares, preference shares or loan financing)? Provide a reason for your answer.

Answer rating: 100% (QA)

Costs of Capital First Alternative Price of share being R250 Dividend of next year Cost of ordinary ... View the full answer