KFP Co, a company listed on a major stock market, is looking at its cost of capital as it prepares to make a bid to buy a rival unlisted company, NGN. Both companies are in the same business sector. Financial information on KFP Co and NGN is as follows:

NGN has a cost of equity of 12% per year and has maintained a dividend payout ratio of 45% for several years. The current earnings per share of the company is 80c per share and its earnings have grown at an average rate of 4·5% per year in recent years.

The ex div share price of KFP Co is $4·20 per share and it has an equity beta of 1·2. The 7% bonds of the company are trading on an ex interest basis at $94·74 per $100 bond. The price/earnings ratio of KFP Co is eight times.

The directors of KFP Co believe a cash offer for the shares of NGN would have the best chance of success. It has been suggested that a cash offer could be financed by debt.

Required:(a) Calculate the weighted average cost of capital of KFP Co on a market value weighted basis. (10 marks)(b) Calculate the total value of the target company, NGN, using the following valuation methods:(i) Price/earnings ratio method, using the price/earnings ratio of KFP Co; and(ii) Dividend growth model. (6 marks)(c) Discuss the relationship between capital structure and weighted average cost of capital, and comment on

the suggestion that debt could be used to finance a cash offer for NGN. (9 marks)

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