The Chief Financial Officer at Isle of Dogs Limited would like to determine the appropriate cost of capital for a new investment project that will be launched at the beginning of 2020. The company currently has 25 million number of ordinary shares outstanding. The company regularly pays ordinary share dividend once a year at the end of each year. Table 1 presents the company's dividend history from 2014 to 2018.

Table 1

Isle of Dogs Limited

Ordinary Share Dividend Paid Annually from 2014 to 2018

Year

Dividend Per Share

2014

$0.98

2015

$0.95

2016

$0.90

2017

$1.05

2018

$1.18

In addition, the company's board of directors has recently declared that a dividend of $1.30 per share will be paid on the last working day of 2019. The board also expects that from 2020 onwards, the company's annual dividend growth rate will be maintained at a constant rate. This rate will be calculated, based on the company's dividend history dated back to 2014, using the mid-point between the arithmetic average and the geometric average. The company's financial analyst has estimated that the company's share price will be approximately $9.85 at the beginning of 2020 and the company's beta will be approximately 1.35.

The company currently has seven long-term bond issues that account for essentially all of its long-term debt. Each bond has $1,000 face value and pays coupon at the end of June and at the end of December each year. Table 2 presents the basic information for the company's bond issues including the estimated prices at the end of 2019.

Table 2

I sle of Dogs Limited

Basic Bond Information including the Estimated Prices at the End of 2019

Bond Issue Number Outstanding Coupon Rate Maturity (End of) Price (% of Par)

1 90,000 6.25% December 2019 95.89%

2 85,000 7.00% December 2024 97.65%

3 80,000 7.50% June 2025 99.87%

4 70,000 8.00% June 2027 101.96%

5 50,000 8.25% December 2029 102.30%

6 40,000 8.50% December 2031 103.42%

7 30,000 8.85% December 2032 105.73%

The company currently has 16.5 million preference shares outstanding, each with $5.50 par value and 8.50% annual dividend. The company's financial analyst has estimated that the company's preference share price will be approximately $6.35 at the beginning of 2020.

The company has a 28% corporate tax rate. Assume that the risk-free rate is 3.0% and the expected return on the stock market is 14.0%.

Using the above information provided, you are required to answer the following questions:

a)Estimate the company's cost of ordinary share using the mid-point between those obtained from the following approaches: dividend growth model and the security market line. Show your calculations.

b)Estimate the company's after-tax cost of debt. Show calculations.

c)Estimate the company's cost of preference share. Show calculations.

d)Estimate the company's market value weighted average cost of capital. Show calculations.

e)Suppose the new investment project being considered has the same risk level as the company's typical project and this project is estimated to yield the internal rate of return (IRR) of 15%. Should the company accept this project? explaination

f)Ignore debt and preference share capital and let's assume that the company's capital structure is financed only by ordinary share capital. If the new investment project being considered has a beta of 1.6 and this project's IRR is estimated to be 19%. Should the company accept this project in this case? What would happen to the company's risk level if it accepted this project? What if it rejected? explaination

g)Suppose the company's Chief Financial Officer would like to use the subjective approach by applying an adjustment factor of 3.0% to the company's cost of capital. By doing so, would this change the company's investment decision made earlier in Part f)? explaination