1. Blackstone Manufacturing is looking into changing its current capital structure as follows:

	Target
Debt	30%
Preferred	20%
Equity	50%

The Finance Director has approached investment bankers of the possibility for the company to raise new debt financing by issuing bonds. According to investment bankers, Blackstone will be able to raise up to RM5 million bonds with 8% coupon rate, beyond which the amount of new debt would require a 9% coupon. Blackstones 7.5% preferred stock, issued at a par value of RM100, currently sells for RM115.50. There are 3,000,000 shares of common stock outstanding with RM3.50 being the most recent dividend declared by the firm. The common stock currently trades at RM40 per share. Management projects next years net income to be RM14,000,000 with 5% growth in the foreseeable future. Floatation costs are 4% on debt and 10% on common and preferred stock. The marginal tax rate is 30%.

1. Compute the cost of capital for the individual components in the capital structure.
2. Calculate the weighted average cost of capital.
3. What role does cost of capital play in the firms long-term investment decisions? How does it relate to the firms ability to maximize shareholder wealth?

B. Your friend, Ahmad, is confused after attending a seminar on capital structuring and has asked you to clarify the concept of cost of capital and the idea of required return on a stock in relation to the risk of an investment. He wonders how capital budgeting tool or cost of capital can be used in handling a very risky investment? Prepare an answer addressing the issues in his query and email it to him.