QUESTION THREE [25]

KRT Ltd feels that some of their machines need to be replaced. They seek your help in order to calculate their cost of capital. Their present capital structure is as follows: 600 000 R2 ordinary shares trading at R2,40 per share. 200 000 preference shares trading at R2,50 per share (issued at R3 per share). 10 % per annum interest. A bank loan of R1 000 000 at 12 % per annum interest. Additional data a. The companys beta is 1,4. Market return is 15% and the risk free rate is 6%. b. Company tax rate is 28%. c. Current dividend is 50c per share and they expect their dividends to grow by 7% per annum.

Required:

3.1 Assuming that the company uses the Capital Asset Pricing Model to calculate their cost of equity, calculate their weighted average cost of capital. (22)

3.2 A further R 750 000 is required to finance the expansion. Which option should they use (from ordinary shares, preference shares or loan financing) and why? (3)