Question

Question 2: JB Communications Ltd is considering an expansion of its existing operations. The following details of the company as at 30 June 1999 are provided for your information. • Debt $10 million (book value) 90-day bank bills with a current interest rate of 6% p.a., maturing 30 September 1999. $20 million (book value) 5-year bonds with an interest rate of 10% p.a. payable on 30 June and 31 December each following year. The face value of each bond is $200,000 and the bonds will mature on 30 June 2004. The required return is 9% p.a. • Equity Ordinary shares to the market value of $20 million. The company income tax rate is 36 cents in the dollar, with franking levels of 80%. Return on the market portfolio is currently 13% p.a., the risk free rate is 7% p.a. and the company’s beta is 0.8. The dividend yield is 5% in the market. Calculate the WARR for the company.

Answer 1

As per the CAPM model, the expected rate of return for an entity is derived using the risk free interest rate.

Expected return (WARR) = Rf + B(Rm-Rf),

where, Rf = Risk free rate of return

Rm = Market return

B = Beta

Hence, WARR = 7 + 0.8(13-7) ;

WARR = 7 + 4.8

WARR = 11.8