Dallas Equipment has the following capital structure:

Long term debt: $2,000,000

Preference share: $500,000

Ordinary share: $2,500,000 (retained earnings and/or new equity)

Debt: The firm can sell a 10-year, $100 par value bond with 10% annual coupon interest rate. The flotation cost is 3% of the par value. A discount of $2 per bond is required to facilitate the selling process. Assume the tax rate is 30%.

Preference shares: Eight percent (annual dividend) preference capital having a par value of $1.00,can be sold for $0.65. An additional fee of $0.02 per share must be paid to the underwriter.

Ordinary shares: The firms ordinary shares are currently selling for $5 per share. The dividend expected to be paid at the end of the coming year (2015) is 40 cents. Dividend payments, which have been about 60% of earnings per share in each of the past 5 years, were as follows:

2014 $0.38

2013 $0.35

2012 $0.33

2011 $0.32

2010 $0.29

It is expected that to sell, ordinary shares must be under-priced by $0.50 per share and the firm must also pay $0.30 per share flotation costs. Dividend payments are expected to continue at 60% of earnings.

• Calculate the cost of capital for each type of capital.
• Calculate the weighted average cost of capital.
• If the earnings available to ordinary shareholders are expected to be $7,000,000, what is the break point associated with the exhaustion of retained earnings.
• Determine the WACC between zero and the break point.
• Determine the WACC just beyond the break point.