Question

You have been appointed as a financial consultant by the directors of Jathig Limited. They require you to calculate the cost of capital of the company. The following information is available on the capital structure of the company:

• 1 500 000 Ordinary shares, with a market price of R4 per share.The latest dividend declared was 90 cents per share. A dividend growth of 13% was maintained for the past 5 years.
• 1 000 000, 12%, R1 Preference shares with a market value of R3 per share.
• R1 000 000, 9%, Debentures due in 7 years and the current yield-to-maturity is 10%.
• R900 000, 14% Bank loan.

Answer 1

The cost of capital is the weighted average of the cost of each component of capital in a company's capital structure. To calculate the cost of capital for Jathig Limited, we need to determine the cost of equity, preference shares, debentures, and bank loan, and then weight them based on their proportion. The cost of capital is determined to be 10.838%.

Step-by-step explanation:

The cost of capital is the weighted average of the cost of each component of capital (equity, preference shares, debentures, and bank loan). To calculate the cost of capital, we need to determine the cost of each component and then weight them based on their proportion in the company's capital structure.

1. The cost of equity can be calculated using the dividend discount model. First, we calculate the dividend per share (DPS) by multiplying the dividend declared by the dividend growth rate (90 cents * 1.13 = R1.017). Then, we divide DPS by the market price per share to get the cost of equity (R1.017 / R4 = 0.25425 or 25.425%).
2. The cost of preference shares is the dividend rate (12%) divided by the market price per share (R3), which is 0.12 / 3 = 0.04 or 4%.
3. The cost of debentures is the yield to maturity (10%), which represents the required return on the debt. Hence, the cost of debentures is 10%.
4. The cost of the bank loan can be considered as the interest rate on the loan, which is 14%.

Next, we weight each component based on its proportion in the capital structure:

1. Weight of equity = Number of ordinary shares / Total number of shares = 1,500,000 / (1,500,000 + 1,000,000 + 200,000 + 200,000) = 0.42857 or 42.857%
2. Weight of preference shares = Number of preference shares / Total number of shares = 1,000,000 / (1,500,000 + 1,000,000 + 200,000 + 200,000) = 0.28571 or 28.571%
3. Weight of debentures = Market value of debentures / Total market value of all components = R1,000,000 / (R1,000,000 + R900,000 + R1,200,000 + R1,200,000) = 0.19802 or 19.802%
4. Weight of bank loan = Value of bank loan / Total market value of all components = R900,000 / (R1,000,000 + R900,000 + R1,200,000 + R1,200,000) = 0.08710 or 8.71%

Finally, we multiply the cost of each component by its weight and sum them up:

(0.42857 * 0.25425) + (0.28571 * 0.04) + (0.19802 * 0.1) + (0.08710 * 0.14) = 0.10838 or 10.838%

Therefore, the cost of capital of Jathig Limited is 10.838%.