A Cost of Capital Problem

You collect the following information on the debt and equity components of Walkure Corporations capital structure. The corporation believes it has an optimal capital structure and will use the current capital structure to calculate its cost of capital.

Capital Structure	Book	Market	Term to	Current	Par
Components	Value	Value	Maturity	Price	Value
	[In millions]	[In millions]	In Years
4.65% Senior Debentures	$ 31.45	$30.19	5	$960.00	$1,000
6.35% Senior Debentures	102.72	100.66	11	$980.00	$1,000
9.10% Subordinated Debentures	82.32	88.08	14	$1,070.00	$1,000
8.40% Preferred Stock	20.98	25.17	perpetual	$30.00	$25
Common Equity	190.00	259.19		$32.00	$1
Totals	$424.47	$503.29

The firm has a marginal income tax rate of 35% and flotation costs currently estimated at 2% on debt issues and 5% on equity issues. The company expects to pay a dividend of $0.40 per share on its common next year and growth is expected to be 6.5% annually in the future.

Assuming no new common stock will be issued to the public -- i.e. all new common equity will be internally generated calculate effective costs and the weighted-average cost of capital for the firm based on the current capital structure, which is assumed to be optimal.

12A. The weights to be used in the calculation of the weighted average cost of capital are:

4.25% Sr Deb 6.35% Sr Deb Sub Deb Pref Common

a. .06 .20 .18 .05 .51

b. .07 .24 .19 .05 .45

c. .07 .28 .15 .05 .45

d. .06 .25 .13 .05 .51

e. .06 .18 .20 .05 .51

12B. The Weighted Average Cost of Capital is:

a. 6.28%

b. 6.46%

c. 7.53%

d. 7.58%

e. 7.69%