PQ$11.$ Pike plc is a quoted company on the London Stock Exchange. The company

operates in the food retailing industry and intends to diversify its operations considering the

heavy competition it is facing.

Pike plc is planning to purchase a company operating in the transport sector and has

identified a coach and rail operator, Great Central Co$.$

Pike plc has the following information in its statement of financial position before its

proposed expansion:

$($million$)$

Ordinary shares, par value $50$p $220$

Retained earnings $650$

$12\%$ unsecured loan stocks $100$

$5\%$ bank loan $200$

The ordinary shares are currently quoted at $3\mathrm{.}50$ each and the loan stocks are trading at

$80$ per $100$ nominal. Pike plc pays tax at $30\%.$

Pike plcs equity beta is currently $1\mathrm{.}2.$ The risk$-$free rate of return is $5\%$ per year and the

market return is $10\%.$

The estimated equity beta of the proposed company, Great Central Co is $1\mathrm{.}35,$ and its

market gearing ratio of debt to equity is $40\%.$ The tax paid by the company is identical to

Pike plc$.$

Required:

a$)$ Calculate the current Weighted Average Cost of Capital $($WACC$)$ of Pike plc

before the investment in Great Central Co$.$

$(7$ marks$)$

b$)$ Estimate the risk$-$adjusted cost of capital that Pike plc should use as the

discount rate for its proposed investment in the transport sector.

$(10$ marks$)$

c$)$ Explain why it would not be appropriate to use the existing WACC of Pi