Reference no: EM132974164

Question - Blue Horizon Lid. (BH) plans to raise new capital for its cobalt mining project in Western Australia. The company will use both debt and equity instruments to fund for the project. It will issue 10-year bonds with a total face value of $50 million. The bonds will pay a 12% yearly coupon and it is known that bonds of equal risk and credit rating are now selling at a yield of 12 % per year. BH's stock has a price of $28 with an expected dividend of $1.20 per share. The growth rate for earnings and dividends is estimated to be 11% per annum. The firm's preference stock is currently selling at $50 per share and carries a dividend of $5.00. The flotation costs are 2.0% of the selling price for the preference shares, any new issue of debt or common stocks will not attract any flotation costs. The capital structure of the firm is comprised of 60% debt, 5 % preference shares and 35% common shares. The relevant 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 a new project. Should it use more equity or debt? In your answer, discuss the potential effect of using more equity or debt on the company's cost of capital.