During the last few years, Mike Rogers Industries has been too constrained by the high cost of capital to make may capital investments. Recently, though , capital cost 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 Mike Rogers' cost of capital. Jones has provided data that she believes is relevant to your task.

(1) The firm's tax rate is 40%

(2) The current price of Mike Rogers' 12 percentage coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Mike Rogers does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation costs.

(3) The current price of the firm's 10 percentage, $100 par value, quarterly ,dividend, perpetual preferred stock is $116.95. Mike Rogers would incur flotation costs equal to 5 percent of the proceeds on a new issue.

(4) Mike Rogers's common stock is currently selling at $50 per share. Its last dividend (D0) was $4.19, and dividends are expected to grow at a constant rale of 5 % in the foreseeable future. Mike Roger's beta is 1.2, the yield on T-bonds is 7 percent, and the market risk premium is estimated to be 6 percent. For the bond-yield - risk-premium approach, the firm uses a 4 percentage point risk premium.

(5) Mike Rogers' target capital structure is 30 percent long-term debt, 10 percent preferred stock, and 60 percent common equity.

To structure the task somewhat, Jones has asked you to answer the following questions:

a. (1) What sources of capital should be included when you estimate Mike Rogers' weighted average cost of capital (WACC)

(2) Should the component costs be figured on a before-tax or an after - tax basis?

(3) Should the costs be historical (embedded) costs or new (marginal) cost?

b. What is the market interest rate on Mike Rogers' debt and its component cost of debt?

COST OF PREFERRED STOCK, rp

c. (1) What is the firm's cost of preferred stock?

COST OF EQUITY (INTERNAL) , rs

d. (1) What are the two primary ways companies raise common equity?

(2) Mike Rogers does not plan to issue new shares of common stock. Using the CAPM approach, what is Mike Rogers' estimated cost of equity?

THE WEIGHTED AVERAGE COSTOF CAPITAL

The weighted average cost of capital (WACC) is calculated using the firm's target capital structure together with its after-tax cost of debt, cost of preferred stock, and cost of common equity.

PROBLEM

e. What is Mike Rogers' weighted average cost of capital (WACC)?