QUESTION TWO

The Rika Company Limited has Sh$.200$ million in total net assets at the end of $2023.$ It plans to increase its

production machinery in the year $2024$ by Sh$.50$ million. Debt financing, at an $11$ percent rate, will sell at par.

Preference shares will have an $11\mathrm{.}5$ percent dividend payment and will be sold at a par value of Sh$.100.$

Ordinary shares currently sell at Sh$.50$ each and can be sold to net Sh$.45$ after floatation costs. There is Sh$.10$

million of internal funding available from retained earnings. Over the past few years, dividend yield has been $6$

percent and the firm's growth rate is $8$ percent. The tax rate is $40$ percent. The present capital structure shown

below is considered optimal.

Required:

$($a$)$ Compute the Company's average cost of equity for the year $2024.(6$ marks$)$

$($b$)$ What would be the Company's weighted average cost of capital if no external equity were used to

finance additional growth $($Assume that where it's not possible to raise the full Sh$.50$ million then the

Company may only increase its production machinery partially.$)?(6$ marks$)$

$($c$)$ The weighted average cost of capital when Sh$.50$ million is raised.$(7$ marks$)$

$($d$)$ Determine the weighted average cost of capital on the extra amount raised over the amount in $($b$)$

above. $(6$ marks$)$