Big Elephant Ltd, a clothing retailer, was founded in 2004. In 2014 it was listed on the JSE at an initial listing price of R2. At the close of the market today the share price was R5.40. The financial director has requested your assistance to calculate the cost of capital. You have been provided with the following information: The breakdown of Big Elephant Capital Structure is as follows:

Ordinary share capital R14 000 000

6 000 000 13% R1 preference shares R 6 000 000

Bank loan 11.96% R 9 500 000

You have also been advised of the following information:

The companys ordinary shares trade at a beta of 1.8, while the industry average beta is 1.5.

Big Elephant Ltd has ten million shares in issue. 2

The companys most recent dividend was 70c per share the directors are following a dividend policy of 8% growth per year. The financial director is of the opinion that they will continue this policy for the foreseeable future.

The preference shares trade at 80c per share

Government bonds trade at 8%.

Assume tax rate of 28%.

The JSE market premium has averaged 9% during the last 12 months.

Required

2.1 Assuming that the company uses the Dividend Growth Model to calculate its cost of equity, calculate its weighted average cost of capital. (18)

2.2 If a further R500 000 is needed to finance the expansion, which option should they use from either ordinary shares, preference shares or loan financing and why? (2)