Riphean and Silurian are two businesses operating in different industries. Both are financed by a mixture of common shares and debt and both are seeking to derive their cost of capital for investment decision making purposes. The following information is available concerning the two businesses for the year to November 30, 2010:

The annual growth rate in dividends is 5% for Riphean and 8% for Silurian. Assume a 30% rate of corporate tax.
Required:
(a) Explain what is meant by the term cost of capital and state why it is important for a business to calculate its cost of capital correctly.
(b) Calculate the weighted average cost of capital of Riphean and Silurian using the information provided.
(c) Discuss two possible reasons why the cost of common share capital differs between the two businesses.
(d) Discuss two limitations of using the weighted average cost of capital when making investment decisions.

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Net income Gross dividends Market value per common share Number of common shares Gross interest yield on debt Market value of debt Riphean $3.0 million $1.5 million $4.00 5 million 8% $10 million Silurian $4.0 million $2.0 million $1.60 10 million 12% $16 million