Tawanda Financial Services (TFS) is made up of $2,300,000 in Common Equity, $1,000,000 in Preferred Equity and $1,700,000 in Debt. TFS recently paid a dividend of $2.50 and the dividends are expected to grow at a rate of 4% for the foreseeable future. Their common stock is currently selling for $20 and the applicable tax rate is 25%.

New preferred shares can be sold to the public at a price of $85 per share, with a dividend of $7. Flotation costs of $5 per share would be incurred. Debt can be raised at an interest rate of 10% and new common equity will only be raised via retained earnings. They plan to maintain the current capital structure after raising additional capital.

i) Calculate the cost of each capital structure component (9 marks)

ii) Determine the weighted average cost of capital for TFS. (6 marks)

b) Addison & Archer Ltd. (AAL) has the following capital structure: 35% Debt and 65% common equity. The after-tax cost of debt is 8% and the cost of common equity is 15%.

i) Given that the tax rate is 25%, what is the weighted average cost of capital? (4 marks)

ii) How would the cost of capital be impacted by a decision to increase the amount of common equity to 75% and reducing the amount of debt to 25%? Explain without calculations. (2 marks)

iii) AAL is considering a project with a with an internal rate of return of 12%. Based on the WACC calculated in part (i) above, should they accept this project? Explain. (4 marks)

Answer rating: 100% (QA)

Tawanda Financial Services TFS i Cost of Capital Components Cost of Common Equity Ke We can use the ... View the full answer