Tswinga Ltd and Muledane Ltd are two businesses operating in different industries from one another. They are both financed by a mixture of ordinary share and loan capital and both are seeking to derive the cost of capital for investment decision making purposes. The following information is available concerning the two businesses for the year ended 31 March 2015.
Tswinga Ltd Muledane Ltd
Profit for the year R3 million R4 million
Gross dividends R1.5 million R2 million
Market value per ordinary share R4 R1.60
Number of ordinary shares 5 million 10 million
Gross interest yield on loan capital (YTM) 8% 12%
Market value of loan R10 million R16 million
The annual growth rate in dividends is 5% for Tswinga Ltd and 8% for Muledane Ltd. Corporate tax rate is 28%.
Required:
a) Calculate the market value weighted average cost of capital (WACC) of Tswinga Ltd and of Muledane Ltd.
b) Discuss two possible reasons why the cost of ordinary share capital differs between the two businesses.
c) Discuss two limitations of using the WACC when making investment decisions.