Silverado Inc is contemplating spending 25 million to expand its
Silverado Inc. is contemplating spending $25 million to expand its mining operation, a project that is considered to have a reasonable amount of risk. Based on some initial analysis, the project would expand the operation’s production output by 18% and provide a 15% return on investment.
Before deciding whether to proceed with the venture, the CEO asked the treasurer to determine where the financing would come from and how much each source will cost. The following are the findings of the treasurer:
a) $11 million will be funded from common shares. Each share will be sold for $50, yielding $4 in dividends. The flotation costs will be 10%.
b) $3 million will be provided from internal sources (retained earnings).
c) $1 million will be generated from preferred shares. The expected selling price is $100, and the flotation costs will be $5 per share. An amount of $10 in annual dividends per share will be paid to the preferred shareholders.
d) $4 million will be funded by the selling of bond A and $6 million by the selling of Bond B. The cost of Bond A is estimated at 6% and the cost of Bond B at 8%.
The company’s corporate tax rate is 47%. The treasurer expects the common shares to continue to grow at a rate of 5% per year.

1. Calculate the company’s cost of capital.
2. Should the CEO approve the expansion program? Why?

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