Question 3 (20 marks) Jay Limited is evaluating investment opportunities with similar expected returns, which will require a total of N$35 million to finance. Last year (2020), a dividend of N$6 per share was paid. At present the shares are quoted at N$60 per share. A dividend growth of 9% per annum is expected for the foreseeable future. The company would realize N$60 per share on the new issue but would have to pay floatation cost of N$5 per share. In addition, 13% preference shares or 11% debentures could be issued. Any debenture issued would be offered at face value. Retained earnings are expected to amount to N$12 million in 2021.

The following are the extract from the 2020 financial statements. These capital structure is based on book values and is considered optimal by the board of directors. Ordinary share capital N$ 23 000 000

Retained Earnings N$ 7 000 000

Total equity N$ 30 000 000

Preference share capital (11% p.a) N$ 9 000 000

Debenture (9% p.a) N$ 21 000 000

Total capital employed N$ 60 000 000 Assume that the tax rate is 30%. Required: a) Determine the amount which must be raised from the issue of new equity in order to finance the investment opportunities while maintaining the current capital structure. (3 marks)

b) Find the after-tax cost of 2021 retained earnings and of new ordinary share capital if raised. (5 marks)

c) Assume that the current yield on long-term government bond is 9% and the market risk premium is 7%. Use capital asset pricing model (CAPM) to determine the firm cost of capital. (5 marks)

d) Calculate the appropriate the weighted-average cost of capital that should be used in the evaluation of the investment opportunities. Use CAPM to determine cost of equity. (7 marks)