The annual report of WTC Ltd provides the following information about the firm. It has 20 million ordinary shares outstanding, and the current market price of the ordinary shares is $1.50 per share. The beta of ordinary shares is 1.5, the market risk premium is 8% p.a. and the risk-free rate is 6% p.a. The firm's debt consists of 100,000 bonds paying an annual coupon rate of 10% and maturing in 4 years' time. Each bond has a face value of $100. The current market yield on the bonds is 8.0% p.a. It also has 150,000 preference shares outstanding, each with a face value of $100.00 and paying a fixed annual dividend rate of 12% p.a. The current market price of the preference shares is $80.00 per share. The company tax rate is 30%.
a) Calculate WTC's before-tax weighted average cost of capital. Show all calculations.
b) Outline the two circumstances in which the weighted average cost of capital cannot be used in analysing the investment projects being considered by the firm.