Reference no: EM132642530

Royta Ltd, operates in the commercial painting industry. They have reluctantly come to the conclusion that some of their older equipment is reaching the end of its productive life and will need to be replaced sooner or later. They have asked for your assistance in determining their cos of capital in order to make their decision.

Their present capital structure is as follows:

1. 1 200 000 R2 ordinary shares now trading at R2.20per share
2. 80 000 preference shares trading at R1.80 per share (issues at R2 per share) interest at 10% p.a
3. A Bank Loan of R1 000 000 at 10.5% p.a (payable in 3 years' time)

Additional data

a. The Company's beta is 1.4. A return on market of 12% is accepted and a risk-free rate of 7% is capable
b. The current tax rate is 30%
c. The Company's current dividend is 43C per share and they expect their dividend to grow by 7% p.a

Required:

Question 1: Assuming that the company uses the CAPM to calculate is cost of equity. Calculate its weighted average cost of capital

Question 2: A further R800 000 is needed to finance the expansion. Which option should they use (from ordinary shares, preference shares or loan financing)? Provide a reason for your answer