Georgia, the vice president of finance of Advanced Instruments, was eager to talk to his investment banker about future financing for the firm. In order to proceed further with the discussion, the banker intended to determine the current cost of capital. The capital structure comprises of bonds and common equity AE05.4 million and AED8.1 million each.
Georgia and his banker determined that the current mix in the capital structure was very close to optimal and that Advanced Instruments should continue with it in the future. The banker was given the cost to issue debt in the past. However, he clarified that the important issue is the current cost of funds, not the historical cost. As a result, he suggested that a comparable firm in the industry, in terms of size and bond rating (BAA), Reuch Instruments, had issued bonds a year and a half ago for 8.5 percent interest at a AED1,000 par value, and the bonds were currently selling for AED750. The bonds had 20 years remaining to maturity.
In terms of cost of common equity, the banker suggested that Georgia use the dividend valuation model as a first approach to determining cost of equity. Based on that approach, Georgia observed that dividend per share was AED1.50, the current stock price was AED30 and the growth rate is approximately 10%.
Determine the weighted average cost of capital. Assume a 35 percent marginal tax bracket.