Reference no: EM132644689

Mining Ltd plans to raise new capital for its cobalt project in Western Australia. The company will issue debt and equity instruments to fund for the project. The company's CFO has asked you to calculate the weighted average cost of capital for the company.

The company intends issue bonds that will pay 8% yearly coupon with a total face value of $60 million. The bonds will mature in 10 years. The firm has been informed by an investment banker that bonds of equal risk and credit rating are now selling at a yield of 10 % per annum. The common stock has a price of $26 with an expected dividend of $1.20 per share. The expected growth rate for earnings and dividends per share is 11% per annum. The preference stock is selling at $50 per share and carries a dividend of $5.00 per share. The flotation costs are 2.0% 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 65% debt, 5 % preference shares and 30% common shares. The corporate tax rate is 30%.

a. Explain the three steps involved in the calculation of cost of capital for the company.

b. Calculate the company's after-tax weighted average cost of capital.

c. Suppose the company is considering raising more capital for another new project. Should it use more equity or debt? In your answer, discuss the effect of using more equity or debt on the company's cost of capital.