Alcaraz Ltd manufactures tennis racquets which it supplies to most of the country’s sportingretailers.You are currently preparing an analysis of a new investment proposal where the internal rate ofreturn has been projected at 15%. The management board has stated that they should go aheadwith this project because the return is higher than the inflation rate, however you have advisedthat they need to compare this rather against the company’s weighted average cost of capital(WACC) before any final decision is made.Upon analysis of the company’s capital structure and latest financial statements as at 31 August2022 you have determined the following: ORDINARY EQUITYOrdinary share capital on the Statement of Financial Position is reflecting as R70 000 000 andconsists of 5 000 000 ordinary shares. The shares are currently trading at a discount of 20% on theJohannesburg Securities Exchange. The beta for the shares is a quarter of the market beta and theshares move in the opposite direction to the market return.PREFERENCE SHARESAlcaraz Ltd currently has eight million (8 000 000), 9% preference shares with a nominal value ofR15 per share in issue. The current market rate for preference shares in the same class hasdecreased to 6%. The company is expected to pay flotation costs of 5%.DEBTFive thousand (5 000) 10-year bonds with a nominal value of R8 000 each are in issue with a 16%coupon rate. The before tax cost of bonds has been calculated at 14%.Additional information:Current market indicators:Currently the risk-free rate of return is 10% and the expected market return is triple the risk-freerate.The company tax rate is currently 28%.You may assume that preference dividends are not tax deductible.Alcaraz Ltd uses the capital asset pricing model (CAPM) to work out the cost of its ordinary shares. 323REQUIRED:Calculate the weighted average cost of capital using the market value method and advise AlcarazLtd as to whether they should go ahead with this investment proposal.
Alcaraz Ltd manufactures tennis racquets which it supplies to most of the country’s sporting
retailers.
You are currently preparing an analysis of a new investment proposal where the internal
return
with this project because the return is higher than the inflation rate, however you have advised
that they need to compare this rather against the company’s weighted average cost of capital
(WACC) before any final decision is made.
Upon analysis of the company’s capital structure and latest financial statements as at 31 August
2022 you have determined the following:
ORDINARY EQUITY
Ordinary share capital on the
consists of 5 000 000 ordinary shares. The shares are currently trading at a discount of 20% on the
Johannesburg Securities Exchange. The beta for the shares is a quarter of the market beta and the
shares move in the opposite direction to the market return.
Alcaraz Ltd currently has eight million (8 000 000), 9% preference shares with a nominal value of
R15 per share in issue. The current market rate for preference shares in the same class has
decreased to 6%. The company is expected to pay flotation costs of 5%.
DEBT
Five thousand (5 000) 10-year bonds with a nominal value of R8 000 each are in issue with a 16%
coupon rate. The before tax cost of bonds has been calculated at 14%.
Additional information:
Current market indicators:
Currently the risk-free rate of return is 10% and the expected market return is triple the risk-free
rate.
The company tax rate is currently 28%.
You may assume that preference dividends are not tax deductible.
Alcaraz Ltd uses the
323REQUIRED:
Calculate the weighted average cost of capital using the market value method and advise Alcaraz
Ltd as to whether they should go ahead with this investment proposal.
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