Company X has the following capital structure, which it considers to be optimal:

Debt =33%,Preferred stock = 28%,Common equity = 39%

Company Xs tax rate is 25% and investors expect earnings and dividends to grow at a constant rate of 6.5% in the future. Company X is expected to pay a dividend of $4.40 per share next year, and its stock currently sells at a price of $55 per share.

Company X can obtain new capital in the following ways:

• Preferred: New preferred stock with a dividend of $13 can be sold to the public at a price of $109 per share.
• Debt: Debt can be sold at an interest rate of 11%.

Calculate the following:

Solutions

A. Cost of Common equity?

Cost of Equity = (Expected Dividend / Current Price) + Growth Rate

= ($4.40 / $55) + .065

=0.145 * 100

= 14.5%

B. Cost of Preferred Equity?

Cost of Preferred Stock = (Preferred Stock Annual Dividend / Preferred Stock Current Price) * 100

= ($13/$109) * 100

= 0.1193* 100

= 11.93%

C. Cost of debt?

Current debt Interest Rate (I) = 11%

= 11 %*( 1 - .25)

=0.11*0.75

=0.0825 *100

= 8.25%

E. Base on each solutions, interpret what the answers are saying.