You are working in the Finance Department of Raceme Manufacturing and your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the firm’s present capital structure reflects the appropriate mix of capital sources for the firm, you have determined the market value of the firm’s capital structure as follows:

Source of Capital ..................Market Values

Bonds ......................................$3,500,000

Preference Shares ................$2,500,000

Ordinary Shares ....................$5,000,000


To finance the purchase, Raceme Manufacturing will sell 10 year bonds paying interest at a rate of 7 percent per year (with interest paid semiannually) at the market price of $1,050. Preferred stock paying a $2 dividend can be sold for $25. Common stock for Raceme Manufacturing is currently selling for $55 per share, and the firm paid a $3 dividend last year. Dividends are expected to continue growing at a rate of 5 percent per year for the indefinite future. If the firm’s tax rate is 30 percent, what discount rate should you use to evaluate the equipment purchase?

Use the formula sheet at the end of the question paper to answer the below questions.

Required:

(a) What is cost of Raceme Manufacturing’s Bonds?
(b) What is Raceme Manufacturing’s cost of preference shares?
(c) What is the cost of Raceme Manufacturing’s ordinary shares?
d) What is Raceme Manufacturing’s WACC?