Cost of Capital

During the last few years, Harry Davis PVT Ltd (HDPL) has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that has been proposed by the marketing department. Assume that you are the company financial analyst. Your task is to estimate HDPLs cost of capital. Finance manager of HDPL has provided you with the following data, which she believes may be relevant to your task.

A) Dividend just paid =$2.35

B) Expected dividend growth rate =5%

C) Current share price= $44

D) Beta of company ordinary share =0.87

E) Risk free rate of return =3.6%

F) Expected return on the market =11%

G) Capital structure is 75% equity and 25% Debt

H) Cost of debt = 5.8%

I) Company tax rate = 30%

Required

1. Calculate cost of equity using the dividend growth model. (5 marks)

2. Calculate cost of equity using the Capital asset pricing model (CAPM). (5 marks)

3. Calculate WACC using cost of equity in 1 above (DGM) (5 marks)

4. Calculate WACC using cost of equity in 2 above (CAPM) (5 marks)

5. Compare and contrast the advantages and disadvantages of using dividend growth model (DGM) based cost of equity, and Capital Asset Pricing Model (CAPM) based cost of equity for determining the WACC? (5 marks)