Question 1 [25 marks]
You have been appointed as a financial consultant by the directors of Goa Ltd. They require
you to calculate the cost of capital of the company. The following information is available on the
capital structure of the company:
✓ 1 000 000 Ordinary shares, with a market price of R4 per share. The latest dividend declared
was 93 cents per share. A dividend growth of 14% was maintained for the past 5 years.
✓ 1 000 000 12%, R1 Preference shares with a market value of R3 per share.
✓ R1 300 000 10% Bank loan, due in December 2034.
Additional information:
1. The company is taxed at 30%.
2. The beta of the company is 1.5, a risk free rate of 5% and the return on the market is 16%.
Required:
1.1 Calculate the weighted average cost of capital (WACC). Use the Gordon Growth Model to
calculate the cost of equity. (22Marks)
1.2 Calculate the cost of equity using the Capital Asset pricing Model (CAPM) (3marks)
1.1 Calculate the weighted average cost of capital (WACC):
Cost of Equity:
Dividend per share = 93 cents
Growth rate = 14%
Market price per share = R4
Cost of Equity using Gordon Growth Model = (Dividend per share * (1+ Growth rate))/(Market price per share)
= (0.93 * (1+0.14))/4
= 0.1071 or 10.71%
Cost of Preference Shares:
Preference dividend = 12% of R1
= 0.12 * 1
= 0.12 or 12%
Cost of Debt:
Bank loan = R1,300,000
Interest rate = 10%
Tax rate = 30%
After tax cost of debt = Interest rate * (1 - Tax rate)
= 0.10 * (1-0.30)
= 0.07 or 7%
WACC = (E/V * Re) + (P/V * Rp) + (D/V * Rd * (1 - T))
Where:
E = Market value of equity = 1,000,000 * R4 = R4,000,000
V = Total market value of the company = R4,000,000 + R1,000,000 + R1,300,000 = R6,300,000
P = Market value of preference shares = 1,000,000 * R3 = R3,000,000
D = Market value of debt = R1,300,000
Re = Cost of equity = 10.71%
Rp = Cost of preference shares = 12%
Rd = After tax cost of debt = 7%
T = Tax rate = 30%
WACC = ((4,000,000/6,300,000)*10.71) + ((3,000,000/6,300,000)*12) + ((1,300,000/6,300,000)*7*(1-0.30))
WACC = (0.6349) + (0.2857) + (0.1816)
WACC = 1.1023 or 11.02%
Therefore, the weighted average cost of capital (WACC) for Goa Ltd. is 11.02%.
1.2 Calculate the cost of equity using the Capital Asset Pricing Model (CAPM):
Cost of Equity = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)
= 5% + 1.5 * (16% - 5%)
= 5% + 1.5 * 11%
= 5% + 16.5%
= 21.5%
Therefore, the cost of equity using the Capital Asset Pricing Model (CAPM) for Goa Ltd. is 21.5%.