Arbitrage Computer is a developer of nanoscale transistor design for computer processors. Arbitrage Computer is funded with a capital structure consisting of $60,000,000 of long-term debt, $140,000,000 of common equity, and $4,000,000 of preferred stock. The stock of Arbitrage Computer recently reached a 52-week high of $132.45 and currently sells for $120.07. Arbitrage Computer is a dividend paying firm and paid a dividend last year in the amount of $3.40. The corporation can issue new common stock with a 4% flotation cost. Their preferred stock pays a dividend of $6.50 per share, and new preferred stock could be sold at a price to net the company $152.60 per share (inclusive of flotation costs). Security analysts are projecting that the common dividend will grow at a rate of 4% a year. The firm can issue additional long-term debt at an interest rate of 4.80%, and its marginal tax rate is 21%. The risk-free rate is 1.11% and the market risk premium is 3.57%. Arbitrage Computer has a beta equal to 1.55.

Part 1: Component Costs

1. Calculate the after-tax cost of debt.

2. Calculate the cost of preferred stock.

3. Calculate the cost of common equity from retained earnings. Use both the dividend growth approach and the CAPM approach.

4. Calculate the cost of new common equity. Use both the dividend growth approach and CAPM approach. For the CAPM approach, find the difference between external and internal equity as determined by the dividend growth approach and add that differential to the CAPM required return from retained earnings.