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11) It is 01 January 20.10 and you have just been appointed financial manager of Tarpo Ltd which is listed on the JSE Ltd. One
11) It is 01 January 20.10 and you have just been appointed financial manager of Tarpo Ltd which is listed on the JSE Ltd. One of your first priorities is to establish the company's cost of capital. To do so you have extracted the following information: Latest statement of financial position as at 31 December 20.09: Notes R 2 400 000 1 400 000 1 400 000 3 800 000 ASSETS Property, plant and equipment Current assets Inventories and receivables Total assets EQUITY AND LIABILITIES Equity Ordinary share capital Reserves Liabilities 17% cumulative redeemable preference shares 10% redeemable debentures Current liabilities Payables and accruals Bank overdraft Total equity and liabilities (0) E 2 000 000 480 000 1 520 000 1 400 000 120 000 1 280 000 400 000 300 000 100 000 3 800 000 (iv) Notes to the financial statements: (i) There are 240 000 shares in issue at a nominal value of R2,00 each. The current market price is R7,68 per share. (i) The preference shares are redeemable in five years' time on 31 December 20.14. Dividends for the year ended 31 December 20.09 have just been paid and similar preference shares are currently trading at a 15% yield per annum. You may assume that the dividends will be paid at the end of each year for the next five years. (ii) The market interest rate for debt in the same class as Tarpo's debentures is 12% per annum and the current market value of Tarpo's debentures is R1,1 million. (iv) The overdraft bears interest at a rate of 20% per annum and will be repaid by 28 February 20.10 when the inventories and receivables from the Christmas season have been reduced. You plan to determine the cost of equity using the capital asset pricing model and have thus made the following estimates of annual returns which will be dependent on the state of the economy: Probability State of the economy Boom Normal Recession Severe recession 20% 50% 20% 10% Tarpo's returns 50% 30% 10% -20% Market returns 40% 20% 10% 0% Additional information: The present capital structure of Tarpo Ltd is considered optimal in terms of its market capitalisation The risk-free rate of return is projected to be 8% per annum. The company tax rate is 30%, and the company is in a tax-paying position. REQUIRED: a) Explain the term 'weighted average cost of capital' and how the company would use it. Calculate the company's current weighted average cost of capital. b)
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