Question
A Carter Company has asked a group of financial consultants to help them determine their component and average costs of capital. The consultants have been
A Carter Company has asked a group of financial consultants to help them determine their component and average costs of capital. The consultants have been able to gather the following information. The company issues a $1,000, 8 percent, 20 years bond which is currently selling at $940. The price of the firms preferred stock is $97 and pays dividends of $13 per year. The common stock has a current price of $40 per share, expects to pay $4 per share in annual dividends next year, and has an expected annual growth rate in dividends of 6%. The book values of the sources of financing are debt at $20,000,000, common stock at $25,000,000, and preferred stock at $5,000,000. The firm is in a 40% tax bracket. The risk free rate is 5% and market risk premium is 6%. Required: i. Calculate the cost of each component of the capital structure (i.e. after tax cost of debt, preferred stock, retained earnings, and the new common stock.) ii. The weighted average cost of capital including all components costs. iii. Why is debt capital less expensive for a firm than equity capital?
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