Seabreeze Limited plans to raise new capital for its project in Tasmania. You ar

Question

Seabreeze Limited plans to raise new capital for its project in Tasmania. You are employed to estimate its cost of capital for use in capital budgeting decision. The treasurer has given you the following information and has asked you to calculate the weighted average cost of capital for the company.

The company currently has an outstanding bond with 12% coupon rate and a convertible bond with an 8.1 % coupon rate. The firm has been informed by an investment banker that bonds of equal risk and credit rating are now selling at a yield of 14 % per annum. The common stock has a price of $30 with an expected dividend (D1) of $1.30 per share. The expected growth rate for earnings and dividends per share is 12% per annum in the future. The preference stock is selling at $60 per share and carries a dividend of $6.80 per share. The flotation costs are 3% of the selling price for the preference shares, no floatation costs will be incurred for any new debt and common stocks issued. The capital structure of the firm is comprised of 45% debts, 5 % preference shares and 50% common shares. The corporate tax rate is 30%.

Calculate the cost of capital for the individual components in the capital structure, and then calculate the weighted average cost of capital for Seabreeze. Consider after-tax cost of capital in your calculations.
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Explanation / Answer

cost of common shares=(current year dividend/stock price)+growth (1.30/30)+0.12 16.33% cost of preferred stock=dividend/market price(1-flotation cost) 6.80/60(1-0.03) 11.68% cost of debt after tax=0.14(1-0.30)=9.8% weighted average cost of capital=45%*9.8%+5%*11.68%+50%*16.33% 4.41+0.584+8.165=13.159%

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