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Question 3 CarCo has in issue 8 million shares with an ex-dividend market value of GH$7.16 per share. A dividend of 62 pesewas per share
Question 3 CarCo has in issue 8 million shares with an ex-dividend market value of GH\$7.16 per share. A dividend of 62 pesewas per share for 2013 has just been paid. The pattern of recent dividends is as follows: CarCo also has in issue 8.5% bonds redeemable in five years' time with a total nominal value of GH\$5 million. The market value of each GHC100 bond is GH\$103.42. Redemption will be at nominal value. CarCo is planning to invest a significant amount of money into a joint venture in a new business area. It has idertified a proxy company with a similar business risk to the joint venture. The proxy company has an equity beta of 1.038 and is financed 75% by equity ard 25% by dekt, on a market value basis. The current risk-free rate of return is 4% and the average equity risk premium is 5%. CarCo pays profit tax at a rate of 30% per year and has an equity beta of 1.6 . Required: (a) Calculate the cost of equity of CarCo using the dividend growth model. (b) Discuss whether the dividend growth model or the capital asset pricing model should be used to calculate the cost of equity. (c) Calculate the weighted average after-tax cost of capital of CarCo using a cost of equity of 12%. (d) Calculate a project-specific cost of equity for CarCo for the planned joint venture. (e) Discuss whether changing the capital structure of a company can lead to a reduction in its cost of capital and hence to an increase in the value of the company
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