Capital current cost of capital with market value weightings

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Reference no: EM131859972

Island Capital has the following capitl structure:

Bonds... $20, 000, 000

Perpetuals (preferred shares)... 4, 000, 000

Common shares... 20, 000, 000

Retained earnings... 19,500,000

$63, 500,000

The existing bonds have a coupon rate of 8 percent with 18 years left to maturity, but current yields on these bonds are 11 percent. Flotation costs of $25.00 per $1,000 bond would be expected on a new issue.

The existing perpetuals have a $25.00 par vlaue and an annual dividend rate of 9 percent. New perpetuals could be issued at a $50.00 par value with 8 percent yield. Floatation costs would be 3 percent.

There are four million common shares outstanding that currently trade at $18.00 per share and expect to pay a dividend next year of $175 that will continue to grow at 7 percent per annum for the foreseeable future. New shares could be issued at $17.50 and would require flotation expenses of 5 percent of proceeds.

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?

Reference no: EM131859972

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