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GOMEZ Co . Ltd wishes to calculate its weighted Average Cost of Capital ( WACC ) before venturing in food processing project. As an expert,

GOMEZ Co. Ltd wishes to calculate its weighted Average Cost of Capital (WACC) before
venturing in food processing project. As an expert, the company presented to you the
current information relating to its capital structure as follows:
Number of ordinary shares 20 million
Number of 5% Tsh.1000 non-callable preferred stock 10 million
Book value of 10% Tsh.10,000 irredeemable bonds Tsh.200 million
Market price of ordinary shares Tsh.500 cum dividend
Market price of 5%, Tsh.1000 non-callable preferred stock Tsh.430 ex-dividend
Total dividend just paid Tsh.40 million
Market price of 10% Tsh.10,000 irredeemable debt 105 percent ex interest
Equity beta of Bamboo company 1.5
Treasury bill rate 5%
Expected return in the market 12%
Additional Information
i. The corporate tax applicable to GOMEZ Ltd is 35%
ii. The dividends of GOMEZ Ltd are expected to grow at an average rate of 6%
The information related to the new project was presented to you as follows:
I. The project will transform an existing warehouse to house the food processing
plant. This will require structural modifications estimated at a cost of
TZS.5,000,000.
I. Electrical installations and construction of access roads are estimated to cost
the company TZS.2,500,000
II. The warehouse currently generates TZS.3,000,000 in rent per annum.
III. Depreciation in warehouse is negligible.
IV. Plant and machinery will be supplied by Fredrick Industries UK who have quoted
price equivalent to TZS.125,000,000.
V. Insurance and freight charges are estimated at a cost of TZS.2,500,000.
VI. Plant installation and test runs are estimated at a cost of TZS.2,250,000.
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VII. The plant has estimated useful life of 5 years and a salvage value of
TZS.1,250,000. Depreciation is on straight line method.
VIII. Due to the nature of the machinery to be imported, the project qualifies for an
investment allowance of 10% of the invoice value.
IX. The project will be financed by both equity and loan funds. Interest of
TZS.3750,000 will be paid per year.
X. The project will generate net revenues before depreciation and tax of
TZS.100,000,000 per annum.
XI. The company will require initial working capital of TZS.1,500,000.
XII. The training of technical staff to operate the machinery will be done by the
supplier of the machinery at a cost of TZS.1,500,000
XIII. You consultancy fee in preparing the feasibility study is estimated at
TZS.8,500,000.
REQUIRED:
(a) Estimate the Bamboos Ltd equity risk premium and cost of equity using the Asset
Pricing Model (CAMP).
(b) Calculate the market value Weighted Average Cost of Capital of Bamboo Ltd
Using:
i. Dividend growth model
ii. Capital Asset Pricing Model
(c) Discuss whether the dividend growth model or the CAPM offers the better estimate
of the equity of the company.
(d) Discuss the circumstances under which the weighted average cost of capital can
be used in investment appraisal.
(e) Derive relevant cash flows of the project.
(f) Calculate the payback period and the net present value of the project.
(g) Basing on results above, advise the Management of GOMEZ Ltd on the viability of
the project.
(h) Explain other factors (if any) you would like to bring to the attention of the
management before a final decision is reached.

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