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The equity beta of Fence Co is 0·9 and the company has issued 10 million ordinary shares. The market value of each ordinary share is K7·50. The company is also financed by 7% bonds with a nominal value of K100 per bond, which will be redeemed in seven years’ time at nominal value.  The bonds have a total nominal value of K14 million. Interest on the bonds has just been paid and the current market value of each bond is K107·14.Fence Co plans to invest in a project which is different to its existing business operations and has identified a company in the same  business area as the project, Hex Co. The equity beta of Hex Co is 1·2 and the company has an equity market value of K54 million. The market value of the debt of Hex Co is K12 million. The risk-free rate of return is 4% per year and the average return on the stock market is 11% per year. Both companies pay corporation tax at a rate of 20% per year. Required: (a) Calculate the current weighted average cost of capital of Fence Co.  (b) Calculate a cost of equity which could be used in appraising the new project.  (c) Explain the difference between systematic and unsystematic risk in relation to portfolio theory and the capital asset pricing model.

The equity beta of Fence Co is 0·9 and the company has issued 10 million ordinary shares. The market value of each ordinary share is K7·50. The company is also financed by 7% bonds with a nominal value of K100 per bond, which will be redeemed in seven years’ time at nominal value.  The bonds have a total nominal value of K14 million. Interest on the bonds has just been paid and the current market value of each bond is K107·14.Fence Co plans to invest in a project which is different to its existing business operations and has identified a company in the same  business area as the project, Hex Co. The equity beta of Hex Co is 1·2 and the company has an equity market value of K54 million. The market value of the debt of Hex Co is K12 million. The risk-free rate of return is 4% per year and the average return on the stock market is 11% per year. Both companies pay corporation tax at a rate of 20% per year. Required: (a) Calculate the current weighted average cost of capital of Fence Co.  (b) Calculate a cost of equity which could be used in appraising the new project.  (c) Explain the difference between systematic and unsystematic risk in relation to portfolio theory and the capital asset pricing model.

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Question Two
The equity beta of Fence Co is 0·9 and the company has issued 10 million ordinary shares. The market value of each ordinary share is K7·50. The company is also financed by 7% bonds with a nominal value of K100 per bond, which will be redeemed in seven years’ time at nominal value. 
The bonds have a total nominal value of K14 million. Interest on the bonds has just been paid and the current market value of each bond is K107·14.Fence Co plans to invest in a project which is different to its existing business operations and has identified a company in the same 
business area as the project, Hex Co. The equity beta of Hex Co is 1·2 and the company has an equity market value of K54 million. The market value of the debt of Hex Co is K12 million. The risk-free rate of return is 4% per year and the average return on the stock market is 11% per year. Both companies pay corporation tax at a rate of 20% per year.
Required:
(a) Calculate the current weighted average cost of capital of Fence Co. 
(b) Calculate a cost of equity which could be used in appraising the new project. 
(c) Explain the difference between systematic and unsystematic risk in relation to portfolio theory and the capital asset pricing model.

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