Posted: April 26th, 2016

How would the cost of capital calculation change if new shares are required to fund the equity component of the capital structure?

Island’s tax rate is 39 percent, and it is expected that internally generated funds will be sufficient to fund capital projects in the near future.

a. Compute Island Capital’s current cost of capital with market value weightings.
b. How would the cost of capital calculation change if new shares are required to fund the equity component of the capital structure?

32. Trois-Rivieres Manufacturing has 10,000 bonds (face value of $1,000 each) with a 10 percent coupon maturing in 8 years. It’s preferreds (100,000 shares) pay a 7.5 percent dividend and it has 600,000 common shares outstanding. Retained earnings are reported at $4,500,000.

During the past five years, Trois-Rivieres Manufacturing has enjoyed a steady growth, with common stock dividends growing from $0.80 to $1.23 (just recently paid). The common share price currently trades at $15. If the new shares were issued at $15, they would require flotation expenses of 7 percent of proceeds.

The preferred shares currently trade at $26.50, and any new issue would require flotation expenses of 5 percent of price to investors.

The bonds currently pay interest semiannually and are trading at a price that yields a nominal 12 percent annual rate (12.36 effective annual rate). Flotation costs of new debt would be 4 percent of proceeds.

Trois-Rivieres tax rate is 38 percent, and equity financing would require a new share issue.

Calculate the weighted average cost of capital of Trois-Rivieres Manufacturing.

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