1. Determine the weighted average cost of capital based on using retained earnings in the capital structure. The percentage composition in the capital structure for bonds, preferred stock, and common equity should be based on the current capital structure of long-term financing as shown in Figure 1 (it adds up to $18 million). Common equity will represent 60 percent of financing throughout this case.

CASE BERKSHIRE INSTRUMENTS Statement of Financial Position Accounts receivable Less Allowance for bad debts 2,300,000 Berkshire Instruments Total current assets Plant and oapenent, original cost-.-- 30,700,000 Al Hansen, the newly appointed vice president of finance of Berkshire Instru- to taik to his investment banker about future financing for the firm. One of AI's first assignments was to determine the firm's cost of capital. In the weights to use in computing the cost of capital, he examined the current (Baa), Rollins Instruments, had issued bonds a year and a half ago for 9.3 percent interest at a S1,000 par value, and the bonds were currently selling for $890. The bonds had 20 years remaining to maturity. The banker also observed that Rollings Instruments had just issued preferred stock at S60 per share, and the preferred stock paid an annuai dividend of $4.80 Liabilities und Stockholders Equity Current liabilities Accrued expenses balance sheet, presented in Figure l 6.120,000 Preferred stock Common siock Common equity Retained conings In terms of cost of common equity, the In their discussion, Al and his investment banker determined that the current mix in the capital structure was very closc to optimal and that Berkshire Instruments should continue with it in the future. Of some concern was the appropriate cost to assign to each of the elements in the capital structure. Ai Hansen requested that his administrative assistant provide data on what the cost ot issue debt and preferred stock had been in the past. The information 6,300,000 Tolal comumon equity Total liabilities and sMockhoiders approach, Al observed that earnings were $3 a share and that 40 percent would be paid out in dividends (D) The current stock was $25. Dividends in the last four years had grown from 82 cents to the current 3,000,000 2,000,000 The banker indicated that the under- writing cost (flotation cost) on a preferred stock issue would be $2.60 per share and S2.00 per share on common stock. AI Hansen further observed that his firm was in Preferrod stock Preserred stock When Al got the data, he felt he was making real progress toward determining the cost of capital for the firm. However, his investment banker indicated that he was formulas: one: one for the cost of retained earnings and one for the cost of new common stock. His investment banker suggested that he follow the normally accepted approach used in determining the marginal cost of capital. First, determine the cost of capital for as large a capital structure as current retained eamings will support: then, determine the cost of capital based on exclusively a 35 percent marginal tax bracket manner. The important issue is the current cost of funds. not the historical cost. The banker suggested that a comparable firm in the industry, in terms of size and bond rating With all this information in hand, Al Hansen sat down to determine his firm's cost of capital. He was a little confused about computing the firm's cost of common He knew there were two different