Island Capital has the following capital structure: Bonds ........................ ......................$20,000,000 Perpetuals (preferred shares)...............4,000,000 Common shares ............... .................20,000,000

Question:

Island Capital has the following capital 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 value and an annual dividend rate of 9 percent. New perpetuals could be issued at a $50.00 par value with an 8 percent yield. Flotation 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 $1.75 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?

Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their... Par Value
Par value is the face value of a bond. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. The market price of a bond may be above or below par,...

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