Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 40 percent. Northwestâs treasurer is trying to determine the corporationâs current weighted average cost of capital in order to assess the profitability of capital budgeting projects. Historically, the corporationâs earnings and dividends per share have increased about 8.2 percent annually and this should continue in the future. Northwestâs common stock is selling at $64 per share, and the company will pay a $6.50 per share dividend (D1). The companyâs $96 preferred stock has been yielding 8 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $6 for preferred stock. The companyâs optimum capital structure is 55 percent debt, 20 percent preferred stock, and 25 percent common equity in the form of retained earnings. Refer to the following table on bond issues for comparative yields on bonds of equal risk to Northwest. Data on Bond Issues Issue Moodyâs Rating Price Yield to Maturity Utilities: Southwest Electric Powerââ7 1/4 2023 Aa2 $ 895.18 8.74 % Pacific Bellââ7 3/8 2025 Aa3 891.25 8.73 Pennsylvania Power & Lightââ8 1/2 2022 A2 970.66 8.77 Industrials: Johnson & Johnsonââ6 3/4 2023 Aaa 880.24 8.55 % Dillardâs Department Storesââ7 1/8 2023 A2 960.92 8.22 Marriott Corp.ââ10 2015 B2 1,035.10 9.77 a. Compute the cost of debt, Kd (use the accompanying tableârelate to the utility bond credit rating for yield) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of debt % b. Compute the cost of preferred stock, Kp. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of preferred stock % c. Compute the cost of common equity in the form of retained earnings, Ke. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of common equity % d. Calculate the weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Weighted Cost Debt (Kd) % Preferred stock (Kp) Common equity (Ke) Weighted average cost of capital (Ka) %
Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 40 percent. Northwestâs treasurer is trying to determine the corporationâs current weighted average cost of capital in order to assess the profitability of capital budgeting projects. Historically, the corporationâs earnings and dividends per share have increased about 8.2 percent annually and this should continue in the future. Northwestâs common stock is selling at $64 per share, and the company will pay a $6.50 per share dividend (D1). The companyâs $96 preferred stock has been yielding 8 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $6 for preferred stock. The companyâs optimum capital structure is 55 percent debt, 20 percent preferred stock, and 25 percent common equity in the form of retained earnings. Refer to the following table on bond issues for comparative yields on bonds of equal risk to Northwest. Data on Bond Issues Issue Moodyâs Rating Price Yield to Maturity Utilities: Southwest Electric Powerââ7 1/4 2023 Aa2 $ 895.18 8.74 % Pacific Bellââ7 3/8 2025 Aa3 891.25 8.73 Pennsylvania Power & Lightââ8 1/2 2022 A2 970.66 8.77 Industrials: Johnson & Johnsonââ6 3/4 2023 Aaa 880.24 8.55 % Dillardâs Department Storesââ7 1/8 2023 A2 960.92 8.22 Marriott Corp.ââ10 2015 B2 1,035.10 9.77 a. Compute the cost of debt, Kd (use the accompanying tableârelate to the utility bond credit rating for yield) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of debt % b. Compute the cost of preferred stock, Kp. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of preferred stock % c. Compute the cost of common equity in the form of retained earnings, Ke. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of common equity % d. Calculate the weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Weighted Cost Debt (Kd) % Preferred stock (Kp) Common equity (Ke) Weighted average cost of capital (Ka) %
Related questions
| Titan Mining Corporation has 9.4 million shares of common stock outstanding, 380,000 shares of 4 percent preferred stock outstanding, and 200,000 8.2 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $42 per share and has a beta of 1.20, the preferred stock currently sells for $92 per share, and the bonds have 10 years to maturity and sell for 113 percent of par. The market risk premium is 8.2 percent, T-bills are yielding 3 percent, and the companyâs tax rate is 35 percent. |
| a. | What is the firmâs market value capital structure? (Do not round intermediate calculations. Round your answers to 4 decimal places, e.g., 32.1616.) |
| Market value weight | |
| Debt | |
| Preferred stock | |
| Equity | |
| b. | If the company is evaluating a new investment project that has the same risk as the firmâs typical project, what rate should the firm use to discount the projectâs cash flows? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
| Titan Mining Corporation has 8.2 million shares of common stock outstanding, 260,000 shares of 4 percent preferred stock outstanding, and 140,000 7 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $30 per share and has a beta of 1.10, the preferred stock currently sells for $80 per share, and the bonds have 10 years to maturity and sell for 110 percent of par. The market risk premium is 7 percent, T-bills are yielding 3 percent, and the companyâs tax rate is 38 percent. |
| a. | What is the firmâs market value capital structure? (Do not round intermediate calculations. Round your answers to 4 decimal places, e.g., 32.1616.) |
| Market value weight | |
| Debt | |
| Preferred stock | |
| Equity | |
| b. | If the company is evaluating a new investment project that has the same risk as the firmâs typical project, what rate should the firm use to discount the projectâs cash flows? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) |
| Discount rate | % |
