Reference no: EM132553932

A company is considering the possibility of raising Rs. 100 million by issuing debt, preference capital and equity and retaining earnings. The book values and the market values of the issues are as follows.

                            Book value                 Market value

Ordinary share                   30                        60

Preference shares              30                         24

Debt                                40                         36

Total                                  100                         120

The following costs are expected to be associated with the above-mentioned issues of capital. (Assume a 35 percent tax rate.)

1. The firm can sell a 20 year, Rs. 1,000 face value debenture with as 16 percent rate of interest, an underwriting fee of 2 per cent of the market price would be incurred to issue the debentures.
2. The 11 percent, Rs. 100 face value preference issue can fetch Rs. 120 per share. However, the firm will have to pay Rs. 7.25 per preference share as underwriting commission.
3. The firm's ordinary share is currently selling for Rs. 150. It is expected that the firm will pay a dividend of Ra. 12 per share, which is expected to grow at a rate of 7 per cent.

Question 1: Compute the weighted average cost of capital using book value weights.