Question $1[30$ marks$]$

Mukuru Fashions Ltd is a is a company that specialises in Men$$s wear. It is based in Sandton City in Gauteng province. All its branches are in Gauteng. The company would like to expand to other provinces. Currently, the company would like to establish branches in the Western Cape province. Recently, in a strategic planning meeting, the management has been planning to raise finance for this expansion. An extract from the statement of financial position $($Balance Sheet$)$ is given below as follows:

Extract of the statement of financial position as at $28$ February $2023$

Capital employed

Share capital

Ordinary shares $(250000$ @ R$2$ each$)$ R$500000$

Non distributable reserves $60000$

Retained income $130000$

Preference shares $(200000$ preference shares of R$1$ each$)200000$

Long $-$term loans $100000$

Bank overdraft $30000$

Ordinary shares

Mukuru has an authorised share capital of $500000$ ordinary shares. The company paid a dividend of R$1,50$ per share in the previous year. The earnings have been growing at a constant rate of $8\%$ per year for the past five years. A dividend cover of $4$ has been maintained for the previous five years. This dividend cover is expected to be maintained for the foreseeable future. Flotation costs for a new share issue are expected to be $10\%$ of the price of such an issue.

Preference shares

Preference shares carry a dividend pay$-$out ratio of $16\%.$ They have no conversion rights. All the dividends have been paid up to date. Similar preference shares have a market pay$-$out ratio of $14\%.$ Issuing costs per new preference share will be R$0,10$

Long term loan

The long$-$term loan carries an interest rate of $12\%$ per year. Any new loans incurred will carry an interest rate of $13\%.$

Bank overdraft

The current prime bank overdraft rate is $10,5\%.$ Mukuru pays a premium of $5\%$ on prime. The bank overdraft is used to finance movements in debtors and inventory. The taxation rate is $28\%.$

Required:

$($a$)$ Calculate the current cost of capital at market values $[6$ marks$]$

$($b$)$ Determine the marginal weighted average cost of capital at market values $($assume a market value of R$1,20$ per preference share$)[6$ marks$]$

$($c$)$ Use the following information to determine the targeted cost of capital $[4$ marks$]$:

$$ Beta coefficient $0\mathrm{.}75$

$$ Market risk premium $8\%$

$$ Risk$-$free rate $9\%$

$$ Interest on the company$$s new long$-$term borrowing $13\%$

$$ Target debt to equity ratio $30\%$

$$ No preference shares in issue

$($d$)$ Discuss which cost of capital rate should be used for appraising any expansion plan $[5$ marks$].$

$($e$)$ Discuss the problems of estimating the weighted average cost of capital when the bank overdraft is used as a source of long$-$term finance. $[5$ marks$]$

$($f$)$ Briefly discuss the factors that would prohibit the issue of new ordinary shares to fund the business. $[4$ marks$]$