You are an Investment Manager at Pegasus Securities and you are preparing for the next meeting of the investment committee. The committee requested you to assess the capital structure of Industrial Production Ltd a manufacturer of industrial products. The following information is available about the company in assisting you in making your assessment.

A. Cost of Equity

Suppose stock in Industrial Production Ltd has a beta of .80. The return on the market 12% percent, and the risk-free rate is 6 percent the firm's last dividend was $1.20 per share, and the dividend is expected to grow at 8 percent indefinitely. The stock currently sells for $45 per share.

Determine the firm's cost of equity capital using the:

i. SML approach

ii. Dividend growth model (8 marks)

B. Calculating the WACC

In addition to the information given in (a) above, suppose Industrial Production ltd has a target debt-equity ratio of 50 percent. Its cost of debt is 9 percent, before taxes. If the tax rate is 35 percent.

Determine the company weighted average cost of capital (WACC) (4 marks)

C. Flotation Costs

Suppose Industrial Production Ltd is seeking $30 million for a new project. The necessary funds will have to be raised externally. The firm's flotation costs for selling debt and equity are 2 percent and 16 percent, respectively.

i. If flotation costs are considered, what is the true cost of the new project? (4 marks)

ii. If Industrial Production Ltd stock currently sells for $50 per share, and the dividend per share will probably be about $5. A shareholder argues, "It will cost the firm $5 per share to use the stockholders' money this year, so the cost of equity is equal to 10 percent ($5/50)."

What is wrong with this conclusion? (4 marks)