QUESTION FOUR [25]

Trendy Limited uses a combination of shares and debt in their capital structure. There are 2 million R1 ordinary shares in issue and the current market price is R2.50 per share. The latest dividend paid was 40 cents and a 9% average growth for the past six years was maintained. The company has 1 000 000 R2, 8% preference shares with a market price of R1.80 per share. Trendy Limited has a public traded debt with a face value of R2 million. The coupon rate of the debenture is 7% and the current yield to maturity of 10%. The debenture has 6 years to maturity They also have a bank overdraft of R600 000 due in 3 years time and interest is charged at 15% per annum.

Additional information:

Trendy Limited has a beta of 2.1, a risk-free rate of 7% and a return on the market of 16%. Company tax rate is 30%.

Required:

4.1 Calculate the weighted average cost of capital, using the Gordon Growth Model to calculate the cost of equity. (22)

4.2 Calculate the cost of equity, using the Capital Asset Pricing Model. (3)