Tembela Manufacturers, operates in the plastic industry. They feel that one of their machines needs to be replaced. They seek your help in order to calculate their cost of capital, and decide whether such a project is viable. Their present capital structure is as follows: 500 000 R2 ordinary shares now trading at R2.30 per share. 180 000 preference shares trading at R2.60 per share (issued at R3 per share). 10 % p.a. fixed rate of dividend.. A bank loan of R1 100 000 at 11 % p.a. (payable over a five year period) Additional data a. The companys beta is 1.3. A return on market of 14.5% and a risk free rate of 6% prevails. b. Its current tax rate is 28%. c. Their current dividend is 50c per share and they expect the dividends to grow by 7 % p.a. Required:

5.3.1. Assuming that the company uses the CAPM to calculate their cost of equity, calculate their weighted average cost of capital. (15)

5.3.2 A further R1 000 000 is needed to finance the machine replacement. Which option should they use (from ordinary shares, preference shares or loan financing) why? (4)