Question
Tailoka is a large company with gearing debt to equity ratio by market values of 1:2.The companys profit after tax in the most recent year
Tailoka is a large company with gearing debt to equity ratio by market values of 1:2.The companys profit after tax in the most recent year were K2,700,000 of which K1,070,000 was distributed as ordinary dividends. The Company has 5 million issued ordinary shares which are currently trading on the LUSE at K3.21.Corporate tax rate is 35% and corporate debt is risk free.Tailoka would want to undertake a new capital project. The project is a major diversification into a new industry. You have been tasked to provide estimates of the discount rate to be used in evaluating this new investment. You have been given the following information showing estimates for the next five years.
Growth rate of own company earnings | 12% |
Average Equity Beta coefficient | 1.5 |
Average industry gearing (debt to equity) ratio | 1:3 by market value |
Average payout ratio | 55% |
Stock market total return on equity | 16% |
Growth rate of own company dividends | 11% |
Growth rate of own company sales | 13% |
Treasury bills | 12% |
Own company dividend yield | 7% |
Own company geared equity beta | 1.4 |
Own company share price rise | 14% |
Required (a) Calculate the companys weighted Average Cost of Capital (WACC) using the Capital Asset Pricing Model (CAPM). (5 Marks) (b) Calculate the companys weighted Average Cost of Capital (WACC) using the dividend valuation model (5 Marks) (c) Describe the situations under which the above two models will produce same values for WACC (3 Marks) (d) Discuss any five (5) practical problems of using CAPM in investment
appraisal.|(5 Marks) (e) Prepare a brief report recommending which discount rate you should use for this investment.Information from pars (a),(b) and (c ) above may be useful. (12 Marks)
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started