As a consultant to GBH Skiwear, you have been asked to compute the appropriate discount rate to use in the evaluation of the purchase of a new warehouse facility. You have determined the market value of the firms current capital structure as follows:

Source of Capital +Market Value

Bonds $500,000

Preference Stocks $100,000

Common Stocks $400,000

To finance the purchase, GBH will sell 20-year bonds with a $1,000 face value paying 8% coupon per year (paid semi-annually) at the market price of $950, with a YTM of 8.53%. Preferred stocks paying a $2.5 dividend can be sold for $35. Common stocks for GBH are currently selling for $50 each. The firm paid a $4 dividend last year and expects dividends to continue growing at a rate of 4% per year forever. The corporate tax rate is 21%.

1. Calculate the weighted average cost of capital of GBH. Show your calculations.

(3 marks)

2. What would be the consequence of using the weighted average cost of capital as the required return of an investment project which has a much lower risk than the overall risk of a firm? Explain briefly.