Unit 4: Cost of Capital (26 marks)

The Directors of Orion Technologies Ltd. (OT) have appointed you as their financial consultant. They are seeking new capital projects for investments and require you to calculate their current present cost of capital to the company as a key in put in the process. The capital structure is listed below:

(i.) 2 million ordinary shares with a par value of 50 cents each, currently trading at R4.00 per share. The company has a beta () of 1.5, a risk free (R f ) rate of 9% and a return on the market (R m ) of 17%.

(ii.) 1.5 million 13%, R2.00 preference shares, with a market value of R2.50 per share.

(iii.) R3 million 11 %, debentures due in 5 years and the current yield-to-maturity is 8%. (iv.) R 700 000, 16% bank loan, due in December 2021.

(v.) The company also has a general reserve of R5 500 000 and a retained income of R6 000 000.

Additional information:

The dividend growth of 10% per annum has been maintained for the past 4 years.

The latest dividend paid was 60 cents per share. Assume a company tax rate of 30%.

Required:

3.1 Calculate the weighted average cost of capital. Use the Capital Asset Pricing Model to calculate the cost of equity. (24 marks)

3.2 Calculate the cost of equity, using the Gordon Growth Model. (2 marks)