Discussion:
A firm is considering a new project which would be similar in terms of risk to its existing projects. The firm needs a discount rate for evaluation purposes. The firm has enough cash on hand to provide the necessary equity financing for the project. Also, the firm:
- has 1,000,000 common shares outstanding
- current price $11.25 per share
- next year's dividend expected to be $1 per share
- firm estimates dividends will grow at 5% per year after that
- flotation costs for new shares would be $0.10 per share
- has 150,000 preferred shares outstanding
- current price is $9.50 per share
- dividend is $0.95 per share
- if new preferred are issued, they must be sold at 5% less than the current market price (to ensure they sell) and involve direct flotation costs of $0.25 per share
- has a total of $10,000,000 (par value) in debt outstanding. The debt is in the form of bonds with 10 years left to maturity. They pay annual coupons at a coupon rate of 11.3%. Currently, the bonds sell at 106% of par value. Flotation costs for new bonds would equal 6% of par value.
The firm's tax rate is 40%. What is the appropriate discount rate for the new project?