Ron’s Online Bookstore Ltd is expanding and they need capital to purchase server

Question

Ron’s Online Bookstore Ltd is expanding and they need capital to purchase servers, computers and a new warehouse. It has decided that it needs to issue more shares on the stock market. It has also decided that it will offer preference shares and ordinary shares. The preference shares have a part value of $80 and pay a 5% dividend. To float the preference shares, they will have to pay their investment bank a floatation cost of 2%.

The company has a beta of 1.15 and there is a market return of 12%. The risk free rate is currently 5%.

Calculate the cost of preference share capital (2.5 marks)

Calculate the cost of ordinary share capital (2.5 marks)

Explanation / Answer

Cost of Preference share capital = Dp/(PV - Floation cost)

Floation cost = 2% * 80 = $ 1.6

Cost of preference shares = 5%* 80/(80-1.6) = 4/78.4 = 5.1 %

Cost of common stock = Risk free rate + Beta* Market risk premium

= 5% + 1.15*(12%-5%) = 20.05%

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