During the last few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice$-$president. Your first task is to estimate Harry Davis$$ cost of capital. Jones has provided you with the following data, which she believes may be relevant to your task:

$1.$ The firm's tax rate is $40$ percent.

$2.$ The current price of Harry Davis$12$ percent coupon, semiannual payment, noncallable bonds with $15$ years remaining to maturity is $$1,153\mathrm{.}72.$ Harry Davis does not use short$-$term interest$-$bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost.

$3.$ The current price of the firm$$s $10$ percent, $$100$ par value, quarterly dividend, perpetual preferred stock is $$116\mathrm{.}95.$ Harry Davis would incur flotation costs equal to $5$ percent of the proceeds on a new issue.

$4.$ Harry Davis$$ common stock is currently selling at $$50$ per share. Its last dividend $($d$0)$ was $$4\mathrm{.}19,$ and dividends are expected to grow at a constant rate of $5$ percent in the foreseeable future. Harry Davis$$ beta is $1\mathrm{.}2$; the yield on t$-$bonds is $7$ percent; and the market risk premium is estimated to be $6$ percent. For the bond$-$yield$-$plus$-$risk$-$premium approach, the firm uses a $4-$percentage point risk premium.

$5.$ Harry Davis$$ target capital structure is $30$ percent long$-$term debt, $10$

percent preferred stock, and $60$ percent common equity.

SOLVE:

$1.$ What is the market interest rate on Harry Davis' debt and its component cost of debt?

$2.$ should flotation costs be inculuded in the estimate?

$3.$ what is the firms costs of preferred stock?

$4.$ Harry Davis$$ preferred stock is riskier to investors than its debt, yet the yield to investors is lower than the yield to maturity on the debt. Does this suggest that you have made a mistake?

$5.$Harry Davis doesn$$t plan to issue new shares of common stock. Using the CAPM approach, what is Harry Davis$$ estimated cost of equity?

$6.$ What is the estimated cost of equity using the discounted cash flow $($DCF$)$ approach?

$7.$What is the cost of equity based on the bond$-$yield$-$plus$-$risk$-$premium method?

$8.$What is your final estimate for the cost of equity, ks$?$

$9.$ What is Harry Davis$$ weighted average cost of capital $($WACC$)?$

$10.$ Harry Davis estimates that if it issues new common stock, the flotation cost will be $15$ percent. Harry Davis incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, taking into account the flotation cost?

$11.$ Supporse Harry Davis issues $30-$year debt with a par value of $$1,000$ and a coupon rate of $10\%$ paid annually. If flotation costs are $2$ percent, what is the after$-$tax cost of debt for the new bond?