Calculate the Weighted Average Cost of Capital (WACC) of Pharma, as at 28 February 2022, based on market values.

EQUITY AND LIABILITIES	Notes		R000
Share Capital	1		15 000
Retained Earnings		100 003
Total Equity		115 003
Non-current liabilities
Long-term debt	2		28 299
Redeemable preference shares	3		10 000
Current liabilities
Short term borrowings		26 634
Trade accounts payable		16 323
Income tax payable		1 944
Total Liabilities		83 200

Pharma issued 15 million ordinary shares of R1 each and the shares are currently trading at R42.62. The dividends that were paid during the last three years were as follows:

2019	2020	2021
200 cents per share	217 cents per share	235,45 cents per share

The Directors are expecting the trend in dividend growth to continue into the foreseeable future.

Note 2

A long-term loan of R 80 million was raised on 1 March 2021. The loan bears annual interest at prime less 0.75%. The loan is repayable in four equal annual payments comprising capital and interest. The market rate for similar loans is 0,5% below the contractual rate of the loan. The loan qualifies as an instrument and is deductible for taxation purposes in terms of Section 24J of the Income Tax Act.

Note 3

100 000 9% Redeemable preference shares of R 100 each were issued on 1 March 2019. These shares are redeemable on 28 February 2024 at a premium of 5%. Market analysts recently reported in the press that similar shares yield 7% per annum.

NEW PROPOSAL

The Research and Development Department have researched a new drug and have proposed that Pharma proceed with its development. Research cost have amounted to R5 million to date. Research conducted estimates that Pharma could sell 5 million units of the drug during the first year of production and that demand will grow by 10% per year for the next three years. The details of the development are summarized as follows:

• The manufacture of the new drug would require the acquisition of a new machine costing
• R 10 million, with 96% payable upfront. The outstanding 4% is payable after one-year.
• Pharma plans to sell the machine after four years and the estimated market value of the machine at that time is R 2 million.
• Working capital required at the start of production will be R 120 000 and this requirement is estimated to grow to R 220 000 at the end of year one. A further R 80 000 will be spent on working capital during the second year of production. In the third year of production the balance of working capital is estimated to be R 360 000. It is expected that the total value of working capital will be recovered at the end of the project.
• The drug will be manufactured and packaged per treatment unit. During the first year, the selling price per unit will be R 32. This selling price is expected to increase by 20% after the first year, and in the third year, it will only increase by 10%. During the final year the selling price will be R 45.
• Packaging costs will be R 1 per unit during the first year and is expected to increase by 50 cent every year thereafter.
• The direct cost of manufacturing a single unit is R 20 during the first year of production. This cost is expected to increase by 15% during the second year and only by 10% during the third year. The cost during the final year will increase by 15%.
• SARS has agreed to allow a wear and tear allowance of 25% per annum on the machine

ADDITIONAL INFORMATION

• The current prime interest rate is 7%.
• Pharma adds 3% to its current WACC rate for investment appraisal purposes.
• Assume a tax rate of 27% for the current year and the foreseeable future
• Pharmas target capital structure comprise 70% equity and 30% debt.