Gbewaa Ghana Ltd has issued 10 million shares with a market value of GH¢5 per share. The equity beta of the company is 1.2. The current yield of short-term government debt is 14% per annum, and the equity risk premium is approximately 5% per annum. The debt finance of Gbewaa Ghana Ltd consists of bonds with a book value of GH¢10,000,000. These bonds pay interest at 18% per annum, and the par value and market value of each bond is GH¢100. The company’s tax rate is 25%.

Required:
Calculate Gbewaa Ghana Ltd’s Weighted Average Cost of Capital. (9 marks)

A colleague has been taken ill. Your managing director has asked you to take over from the colleague and to provide urgently-needed estimates of the discount rate to be used in appraising a large new capital investment. You have been given your colleague’s working notes, which you believe to be numerically accurate.

Working notes: Estimates for the next five years (annual averages)
Stock market total return on equity                                                     16%
Own company dividend yield                                                                7%
Own company share price rise                                                             14%
Standard deviation of total stock market return on equity              10%
Systematic risk of own company return on equity                            14%
Growth rate of own company earnings                                              12%
Growth rate of own company dividends                                            11%
Growth rate of own company sales                                                    13%
Treasury bill yield                                                                                  12%

The company’s gearing level (by market values) is 1 : 2 debt to equity, and after-tax earnings available to ordinary shareholders in the most recent year were GH¢54,000,000, of which GH¢21,400,000 was distributed as ordinary dividends.

The company has 1 million issued ordinary shares which are currently trading on the Stock Exchange at GH¢3.21. Corporate debt may be assumed to be risk-free. The company pays tax at 30% and personal taxation may be ignored.
Required:
Estimate the company’s weighted average cost of capital using:                              (10 marks)

State clearly any assumptions that you make.
Under what circumstances these models would be expected to produce similar values for the weighted average cost of capital?
i) The dividend valuation model;

ii) The capital asset pricing model.

M&E Ltd, recognised as the leader in steel manufacturing, has received an invitation to supply steel for the construction of rail lines to connect the ECOWAS countries, starting from Nigeria. The contract will be for 10 years, and management is considering appraising the investment to enable them present their proposals for the contract. The following information was extracted from the recently published accounts of M&E Ltd.

The Treasury unit of M&E Ltd has estimated that it will require GH¢ 10 million to finance the new project. The total amount would be raised through 10% Irredeemable bonds at the current market price. The cost of Preference shares and Bonds will not change but equity shareholders will demand an increase of 20% on the current cost of equity.

M&E Ltd has a beta of 0.8, the market risk premium for the steel industry is 6.25%, and the Government of Ghana Bond rate is 20%. The current market price for Irredeemable Bonds of GH¢1,000 nominal value is GH¢850.

M&E Ltd’s dividend policy is to pay constant dividend and this policy will not change into the foreseeable future. The recent dividend paid was GH¢20 per share. M&E Ltd is a Free Zones Company and therefore pays tax at a rate of 8%.
Required:
i) Calculate the current market capitalization of M&E Ltd.                                                                                              (5 marks)

ii) Calculate the Weighted Average Cost of Capital (WACC) prior to the consideration of the finance for the proposed project.                                                                                                                                                                                     (9 marks)

The Finance Director of Vista Hotel has heard that the market value of the company will increase if the weighted average cost of capital of the company is decreased. The company, which is listed on a stock exchange, has 100 million shares in issue and the current ex div ordinary share price is GH¢2·50 per share. Vista Hotel also has in issue bonds with a book value of GH¢60 million and their current ex interest market price is GH¢104 per GH¢100 bond. The current after-tax cost of debt of Vista Hotel is 7% and the tax rate is 30%. The recent dividends per share of the company are as follows:

The Finance Director proposes to decrease the weighted average cost of capital of Vista Hotel and hence increase its market value, by issuing GH¢40 million of bonds at their par value of GH¢100 per bond. These bonds would pay annual interest of 8% before tax and would be redeemed at a 5% premium to par after 10 years.

Required:

ii) Calculate the weighted average cost of capital of Vista Hotel in the following circumstances:

• before the new issue of bonds takes place;                                                                  (3 marks)

• after the new issue of bonds takes place.                                                                   (3 marks)

SAFOO Ltd has in issue 5 million shares with a market value of GH¢ 3.81 per share. The equity beta of the company is 1.2. The yield on short- term government debt is 23% per year and equity risk premium is 5% per year. The debt finance of SAFOO Ltd consists of bonds with a total book value of GH¢2 million. These bonds pay annual interest before tax of 25%. The par value and market value of each bond is GH¢100. The Company pays tax at 25%.
Required:
Calculate SAFOO Ltd Weighted Average cost of Capital.                                                                                         (10 marks)