Sharp Meats has determined its optimal capital structure, which is composed of the following sources and target market value proportions:
Long term debt 30%
Preference share capital 5%
Ordinary share equity capital 65%
Sharp Meats can sell a 20 year, $1 000 par value, 9 per cent coupon rate bond for $980. A flotation cost of 2 per cent of the face value would be required in addition to the discount of $20. The firm has determined it can issue preference shares at $65 per share. The shares will pay a dividend per share of $8. The cost of issuing and selling the preference shares is $3 per share. The firm's ordinary shares are currently selling for $40 per share. The firm expects to pay a dividend at the end of the coming year of $5.07 per share. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.45 per share. It is expected that to sell, a new ordinary share issue must be underpriced $1 per share and the firm must pay $1 per share in flotation costs. The firm's marginal tax rate is 40 per cent.
1. Calculate the firm's weighted average cost of capital assuming that the firm has exhausted all retained earning.
2. In general, what factors determine a firm’s cost of capital? In answering this question, identify the factors that are within management’s control and those that are not.