Highlight four uses of the cost of capital to a limited liability company.    (4 marks)

The Finance Manager of Maguru Limited has compiled the following information regarding the company's capital structure.                                                      

             Ordinary shares

 The company's equity shares are currently selling at Shs. 100 per share.  Over the past five years, the company's dividend pay-outs which have been approximately 60% of the earnings per share were as follows:

 

Year ended 30 September	Dividend per share
	Shs.
2020	6.60
2019	6.25
2018	5.85
2017	5.50
2016	5.23

The dividend for the year ended 30 September 2020 was recently paid.

The average growth rate of dividend is 6% per annum.

To issue additional ordinary shares, the company would have to issue at a discount of Shs. per share and it would cost Shs. 5 in floatation cost per share.

The company can issue unlimited number of shares under the above terms.

 Preference shares

The company can issue an unlimited number of 8% preference shares of Shs. 10 par value at a floatation cost of 5% of the face value per share.

 Debt

The company can raise funds by selling Shs. 100, 8% coupon interest rate, 20 year bonds, on which annual interest will be made.

The bonds will be issued at a discount of Shs. 3 per bond and a floatation cost of an equal amount per bond will be incurred.

 Capital structure

 The company's current capital structure, which is considered optimal, is:

	Shs.
Long term debt	30,000,000
Preference shares	20,000,000
Ordinary shares	45,000,000
Retained earnings	5,000,000
	100,000,000

The company is in the 30% tax bracket.

 Required:

(i)  The specific cost of each source of financing.      

Answer rating: 100% (QA)

i Specific cost of each source of financing Ordinary shares The cost of issuing new ordinary shares ... View the full answer