Question
Brooks Window Shields Inc. (Brooks) is trying to calculate its cost of capital for use in a capital budgeting decision. Mr. Glass, the vice-president of
Brooks Window Shields Inc. (Brooks) is trying to calculate its cost of capital for use in a capital budgeting decision. Mr. Glass, the vice-president of finance, has given you the following information and has asked you to compute the weighted average cost of capital.
The company currently has an outstanding bond with a 10 percent coupon rate and another bond with a 11 percent coupon rate. The firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 12.2 percent.
The ordinary shares have a price of R70 and an expected dividend (D1) of R5.50 per share. The firm's historical growth rate of earnings and dividends per share has been 12 percent, but security analysts on Wall Street expect this growth to slow to 5 percent in future years.
The preference shares are selling at R66 per share and carry a dividend of R6.50 per share. The corporate tax rate is 30 percent. The flotation cost is 3.1 percent of the selling price for preference shares.
Equity = 65000
Share Capital = 5000
Retained Earnings = 40000
Preference Share Captial = 20000
Liabilities = 35000
Current Borrowings = 5000
Non Current = Borrowings = 30000
(a) Compute the cost of capital for the individual components in the capital structure. (Do not round intermediate calculations)
(b) Calculate the weighted cost of each source of capital and the weighted average cost of capital.
(c) Discuss whether you think the weighted average cost of capital should be used for this specific project and whether any adjustments are necessary? Should Brooks management also adjust their optimal capital structure?
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