Cost of Capital

Eastman Chemical Co., a leading international company and maker of plastics, has the following four projects to consider. Assume that all four projects are of average risk.

	Return
Project A	6.00%
Project B	6.40%
Project C	6.60%
Project D	7.00%

You are an assistant to the CFO and have collected the following data to conduct the analysis.

The company is subjected to a marginal tax rate of 35%.

The company can issue a 20-year, 7.6% semi-annual coupon bond at $1,219. New bonds would be privately placed with no floatation cost.

The companys preferred stock currently sells for $30 per share. It pays a fixed dividend of $1.8 per share.

The companys common stock currently sells for $40 per share. The most recently paid dividend was $1 per share. Dividends are expected to grow at a constant rate of 5% in the foreseeable future.

A flotation cost of 10% would be required to issue new common stock.

The companys stock beta is 1.875, the market risk premium is 3% and the risk-free rate is 2%.

The companys capital structure consists of 30% debt, 5% preferred stock, and 65% common equity.

Estimate the cost of the following capital components

Cost of Debt

Cost of Preferred Stock

Cost of Retained Earningsbased on DCF approach

Cost of Retained Earningsbased on CAPM approach

Cost of New Common Stock ---based on DCF approach

What is the firms WACC if it uses only retained earnings for equity? Which projects should the firm select?

What is the firms WACC if the firm expands so rapidly that it must issue new common stock? Which projects should be the firm select in this case?