QUESTION 5 You are the CFO of Dandenong Dairy Ltd. The company has an interest rate on its debt of 8 per cent per annum. The systematic risk of its equity is 1.4 and the effective company tax rate is 0.20. 30 per cent of its funding is provided by debt, while 70 per cent is provided by equity. The risk- free interest rate is 4 per cent per annum. In calculating its cost of capital, Dandenong Dairy has obtained two expert opinions as to the market risk premium (including the franking premium). One expert suggests that the market risk premium is 2 per cent per annum, while the other suggests that the market risk premium is 5 per cent per annum. REQUIRED: (a) What is Dandenong Dairy's cost of capital based on these expert's opinions of the market risk premium? Show all workings. (5 marks) (b) The first expert also suggests that "It is obvious that the companies should use as much debt as possible. It is cheaper than equity and the interest is tax deductible as well." Do you agree with the statement? Justify your answer. (5 marks) (c) When can the cost of capital for Dandenong Dairy be a valid measure of the cost of capital for a new project? (5 marks) (5 + 5 + 5 = 15 marks) QUESTION 5 You are the CFO of Dandenong Dairy Ltd. The company has an interest rate on its debt of 8 per cent per annum. The systematic risk of its equity is 1.4 and the effective company tax rate is 0.20. 30 per cent of its funding is provided by debt, while 70 per cent is provided by equity. The risk- free interest rate is 4 per cent per annum. In calculating its cost of capital, Dandenong Dairy has obtained two expert opinions as to the market risk premium (including the franking premium). One expert suggests that the market risk premium is 2 per cent per annum, while the other suggests that the market risk premium is 5 per cent per annum. REQUIRED: (a) What is Dandenong Dairy's cost of capital based on these expert's opinions of the market risk premium? Show all workings. (5 marks) (b) The first expert also suggests that "It is obvious that the companies should use as much debt as possible. It is cheaper than equity and the interest is tax deductible as well." Do you agree with the statement? Justify your answer. (5 marks) (c) When can the cost of capital for Dandenong Dairy be a valid measure of the cost of capital for a new project? (5 marks) (5 + 5 + 5 = 15 marks)