Reference no: EM132396728

Jim Dutton is the CEO of Au Pair Migration Services Ltd which has recently changed its target capital structure and expects to maintain it for future investments. This target capital structure is reflected in the current market value of the financing already undertaken: $272,000 in debt, $428,000 in preference shares and $400,000 in ordinary equity. The following data has been collected to calculate the new weighted average cost of capital.

1. 100,000 new ordinary shares will be issued with the current market price of $4.00. $40,000 in dividends was paid out this year. Dividends are expected to grow at the annual rate of 5%. To float this new issue the firm would have to offer a discount of $0.30 per share below market price. The cost of such an issue is expected to be $0.20 per share.
2. 100,000 new preference shares will be issued with the current market price of $4.28 each with dividends of $0.50 per share. Issue cost for preference shares is 2% of the market price.
3. The cost of debt (before tax and after issue costs) has been calculated as 12.72% pa. The firm's tax rate is 30%.

Required

1. Calculate the weighted average cost of capital (WACC) for Au Pair Migration Services Ltd.
2. Discuss how much reliance Financial Managers should put on the weighted average cost of capital (WACC) approach to determining the cost of capital for evaluating capital budgeting projects.
3. How does the WACC approach compare to the CAPM for determining a firms cost of capital? When should each approach be used?