The annual report of Matrix Corporation discloses the following information about the company

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The annual report of Matrix Corporation discloses the following information about the company. It has 21.6 million ordinary shares on issue, ordinary issued capital of £43.2 million and retained profit of £18.5 million. The company pays dividends annually and the most recent dividend was 25 pence per share. Its debt consists of 80,000 15% bonds, maturing in 3 years’ time; each bond has a face value of £100. It also has 150,000 preference shares (or preferred stock) on issue, each with a face value of £50, and paying a fixed dividend rate of 12% per year.

The current market price of the ordinary shares is £1.36 per share. The current market yield on the bonds is 8.55% per year. The current market price of the preference shares is £42.50 per share. Dividends are estimated to grow at 3.5% per year indefinitely.

1. Calculate Matrix Corporation’s weighted average cost of capital. Show all calculations.

2. You show your calculations to a colleague, who argues that the dividend growth model is an unreliable way of estimating the cost of equity capital. She suggests you should use the capital asset pricing model. You take her advice, and you estimate Matrix Corporation’s beta to be 1.5, the risk-free rate to be 4% and the expected return on the market portfolio to be 13%. Calculate your new estimate of WACC.

 

3. In what circumstances is it appropriate for Matrix Corporation to use the WACC determined in part (i) as the "hurdle rate" in project evaluation? Limit your answer to no more than 50 words.