Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 40 percent long-term debt, 10 percent preferred stock, and 50 percent common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 40 percent.

Debt. The firm can sell for R980 a 10-year, R1 000-par-value bond paying annual interest at a 10 percent coupon rate. A flotation cost of 3 percent of the par value is required in addition to the discount of R20 per bond.

Preferred stock/preference shares. Eight- percent (annual dividend) preferred stock having a par value of R100 can be sold for R65. An additional fee of R2 per share must be paid to the underwriters.

Common stock/ordinary shares. The firm's common stock is currently selling for R50 per share. The dividend expected to be paid at the end of the coming year (2004) is R4. Its dividend payments, which have been approximately 60 percent of earnings per share in each of the past 5 years, were as shown in the following table.

Year

Dividend

2003 R3.75

2002 3.50

2001 3.30

2002 3.15

1999 2.85

a. If earnings available to common shareholders are expected to be R7 million, what is the breaking point associated with the exhaustion of retained earnings?

b. Determine the weighted average cost of capital just beyond the breaking point calculated in a.