Happy Gilmore co. is trying to calculate its cost of capital for use in a capital budgeting decision. Mr. Shooter, the vice president of finance, has given you the following information and has already asked you to compute the weighted average cost of capital.
The company currently has outstanding bond with an 11.20% coupon rate and another bond with a 7.5% rate. The firm has been informed by its investment banker that bonds of equal risk and credit ratings are now selling to yield 12.4%
The ordinary share has a price of P54.00 and expected dividend (D1) of P2.70 per share. The firm's historical growth rate of earnings and dividends per share has been 14.5%, but security analysts expect this growth to slow to 12% in future years.
The preference share is selling at P50 per share and carries a dividend of P4.75 per share. The corporate tax rate is 35%. The flotation cost is 2.8% of the selling price for preference share. The optimum capital structure for the firm seems to be 35% debt, 10% preference share, and 55% ordinary equity in the form of retained earnings.
Compute the cost of capital for the individual components in the capital structure, and then calculate the weighted cost of capital. Explain the significance of your answer.