QUESTION THREE [25]

3.1 Cassava Ltd, operates in the farming industry. They feel that some of their older gas welding machines need to be replaced. The company's present capital structure is as follows: 600 000 R2 ordinary shares now trading at R2,40 per share. 200 000 preference shares trading at R2,50 per share (issued at R3 per share). The shares pay a fixed dividend of 7% per annum. A bank loan of R1 000 000 at a nominal interest rate of 12% p.a. The company's beta is 1,4. A return on market of 15% and a risk- free rate of 6%. The tax rate is 28%. Its current dividend is 50c per share and they expect their dividends to grow by 7% p.a.

Required:

3.1.1 Calculate their cost of equity capital. (5)

3.1.2 What is the cost of the preference share capital? (5)

3.1.3 Calculate their weighted average cost of capital. (10)

3.1.4 A further R500 000 is needed to finance the expansion which option should they use (from ordinary shares, preference shares or loan financing) and why? (5)