Company DEF is analyzing whether to issue debt or preference shares. The corporate tax rate is 45%. Interest income is taxed at 30%. The tax rate on dividends and gains from capital is 12%. Dividends on preference shares are not allowed as a deduction from corporate tax.

Required:

i. Calculate the cost of capital for preference shares if the debt interest rate is 5%.

ii. Calculate the debt cost of capital after taxes and compare it with the cost of capital of preference shares calculated above. Should the company issue debt or preference shares?

iii. Show the relationship between the debt cost of capital after taxes, preference shares cost of capital, and .