Reference no: EM132657502

HK's capital structure consists of a single long-term debt issue with a face value of $20 million and 2 million common shares with a current market price of $15 per share.

The long-term debt issue carries a coupon rate of 5% with interest paid semi-annually. It has eight years remaining until maturity and a current market yield of 6%, also based on semi-annual compounding.

The common shares have a beta of 1.15. HK paid a dividend of $0.95 per share in its most recently completed financial year. Analysts believe these dividends will grow at an average annual rate of 3% for the foreseeable future. The current risk-free interest rate is 2.5%, and the market price of risk is 6%.

Recent discussions with HK's investment banker have indicated that flotation costs would be 7% before tax on any new issue of common shares and 4% after tax on any new issue of long-term debt.

What is the required rate of return on HK's common shares if internally generated funds will be sufficient to finance the equity portion of any new financing and:

a) the capital asset pricing model (CAPM) is used to determine the shares' required rate of return?

b) the constant-growth dividend discount model is used to determine the shares' required rate of return?