Huron Ltd. has the following capital structure:

16% Debentures, due in 14 years.....................$30,000,000
Preferreds (8% dividend, 40,000 shares)..............3,000,000
Common shares: 3,600,000 outstanding .............7,200,000
Retained earnings ......................... ......................5,600,000
Foreign currency translation ... . .. .. .. . ... . ......... 2,200,000

...........................................................................$48,000,000

In today's capital markets, a company with risk characteristics similar to Huron's would be subject to the following yields:
• Bank prime rate is 7 percent.
• The average yield on 91 dayT-bills is 5 percent.
• Debentures would require a yield of 9.5 percent. Flotation costs aftertax would be 4 percent.
• Preferreds would require a yield of 6.5 percent. Flotation costs aftertax would be 5 percent.
• The market portfolio is anticipated to yield 13 percent over the next year.
• Huron's historical beta is 1.25.
Huron's shares currently trade at $15.50. A new issue would net $15.00, including aftertax flotation costs. Internally generated funds will be sufficient to fund Huron's upcoming enterprises. Huron's tax rate is 40 percent.
a. Calculate Huron Ltd.'s cost of capital.
b. A major new investor in Huron is concerned with the possible rejection of viable business proposals based on the calculations just performed. The shareholder suggests that Huron can borrow at prime plus 1 percent and that should be good enough as a discount rate. Prepare a reply to the shareholder. (A "Yes, sir" or "No, ma'am" is not a correct answer.)