Question 2: JB Communications Ltd is considering an expansion of its existing operations. The following details...

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.

Solutions

Expert Solution

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

jeff jeffy answered 2 years ago

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