QUESTION 3

The directors of Pav Limited have appointed you as their financial consultant. They are considering new investment projects and need you to calculate the cost of capital for the company.

The present capital structure is as follows:-

• 3 450 000 ordinary shares with a par value of 75 cents per share. These shares are currently trading at R4.50 per share and the latest dividend paid is 30 cents. An average dividend growth of 13% is maintained.
• 500 000 14% R3.00 preference shares, with a market value of R5.00 per share.
• R5 000 000 non-distributable reserves
• R5 200 000 8% debentures due in 6 years' time and the current yield-to-maturity is 6%, and
• R1 000 000 13% bank loan.

Additional information:

• The company has a beta of 1.8, a risk-free rate of 6% and enjoys a premium of 9%.
• The company's tax rate is 30%.

Required:

3.1 Calculate the weighted average cost of capital, using the Gordon Growth Model to calculate the cost of equity. (20 marks)

3.2 Calculate the adjusted weighted average cost of capital, using the Capital Asset Pricing Model as the cost of equity. (5 marks)