Question

Matilda Confectioneries seeks your advice in measuring its overall cost of capital. The firm is in the 30% tax bracket. You have collected the following information.

Sources of Capital	Market price	New issue cost	Dividend/Coupon rate	Target capital Structure
Common Shares	$40.00	(see note 1)	(see note 1)	60%
Preferred shares	$50.00	$4.00	$5.25	20%
$1,000 Coupon Bond with 12 years to mature	$950.00	$20.00	12% (see note 2)	20%

Note 1: A new equity share issue will be priced $1.50 less than the current market price of the share. The issue will also cost $2.00 per share in flotation costs. During the last five years, the cash dividend paid for the common shares has grown from $3.74 to $5.00. The company expects to maintain the same dividend growth rate in the future.

Note 2: The company pays coupon payment semi-annually

Required:
a. Explain the alternative methods which can be used to estimate the cost of common equity. (2 Points)
b. Calculate the individual cost of each source of financing. (6 Points)
c. Calculate the firm’s weighted average cost of capital (WACC) using the given market value based weights. (2 Points)

Answer 1