During the last few years, Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently capital costs have been declining and the company has decided to look seriously at a program proposed by marketing department. The company's financial vice president Jones and you are his assistant. Now your 1^st task is to estimate Davis cost of capital. Jones has provided you following data relevant to your task:

1.Firm's tax rate = 40%

2.Current price of Davis 12% coupon, semiannual payment, non-callable bonds with 15 years remaining to maturity is $1,153.72. Davis does not use short-term interest bearing debt on permanent basis. Bond would be privately placed with no flotation cost.

3.Current price of the firm's=10%, $100 par value, quarterly dividend, perpetual preferred stock= $116.95. Davis would incur flotation costs equal to 5% of the proceeds on a new issue.

4.Davis common stock is currently selling at $50 per share. Its last dividend was D0=$3.12, dividends are expected to grow at a constant rate of 5.8% in the foreseeable future. Davis beta=1.2 and the yield on T-bonds is 5.6%, the market rate premium is estimated to be 6%.

5.Davis target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity.

Q 1.What source of capital should be included when you estimate Davis weighted average cost of capital? Should the component costs be figured on a before-tax or an after-tax basis?

Q 2.What is the market interest rate on Davis debt, and what is the component cost of this debt of WACC purposes?

Q 3.Why Davis preferred stock is riskier to investors than its debt? Explain?