Santam wants to determine its cost of capital. The company is financed through bonds and ordinary shares. The bonds were issued five years ago at a par value of R100 (total funds raised R5 million). They carry an annual coupon of 12 per cent, are due to be redeemed in four years and are currently trading at R110. The company’s shares have a market value of R4 million, the return on risk-free government securities is 9 per cent and the risk premium for an average-risk share has been 6 per cent. Santam’s shares have a lower than average risk and its historic beta, as measured by the co-movement of its shares and the market index, correctly reflects the risk adjustment necessary to the average risk premium – this is 0.90. The corporate tax rate is 30 per cent. Santam has a net asset figure of R3.5 million showing in its statement of financial position.
Required:
1 Calculate the cost of debt capital.
2 Calculate the cost of equity capital.
3 Calculate the weighted average cost of capital.
4 Should Santam use the WACC for all future projects and SBUs? Explain your answer.