how do I calculate cost of debt using YTM, cost of preferred stock, and cost of common equity.

Black: Although each of these methods has its merits, I believe that the most appropriate approach for our company would be to find an average cost with the three methods. Fred Black gave only one week to Jane Jefferson for her estimation of SMC's WACC. With the instructions she received from Black and with the help of the financial data in Exhibit 1, Jefferson began the task of estimating the company's WACC immediately Fred Black knew that estimating the company's cost of capital was the first critical step in the capital budgeting process. Without this analysis, it would not be possible to determine if the new system would be a profitable investment for SMC. That is why he had asked Jefferson to estimate the company's WACC as the first task. Black was very pleased when he received Jefferson's calculations and the WACC estimate. He thought that he had made a good decision in hiring Jefferson as the head of the company's newly established Capital Budgeting Department. Exhibit 1: Financial Data for Calculating SMC's WACC SMC's current market value capital structure Bonds Preferred Stock Common Equity Total $35,000,000 (35%) $15,000,000 (154) $50.000.000.15095 $100,000,000 Data to be used in the calculation of the cost of debt: Par value $1,000, non-callable Market value $1,085.59 Coupon Interest -6%, annual payments Remaining maturity = 20 years New bonds can be privately placed without any flotation costs Data to be used in the calculation of the cost of preferred stock: Par value = $100 Annual dividend = 7.5% of par Market value - $102 Flotation cost 4% Data to be used in the calculation of the cost of common equity: CAPM data: VEC's beta = 1.2 The yield on T-bonds -3% Market risk premium 7% DCF data: Stock price = $27.08 Last year's dividend (DO) = $2.10 Expected dividend growth rate=4% Bond-yield-plus-risk-premium data: Risk premium = 5.5% Amount of retained earnings available = $80,000 Floatation cost for newly issued shares = 7% SWAGGER MANUFACTURING COMPANY CAPITAL BUDGETING DECISION Swagger Manufacturing Corporation (SMC) is planning to invest in new machinery to produce a new product line. The invoice price of the machinery is $320,000. It would require $10,000 in shipping expenses and $20,000 in installation costs. The machinery falls in MACRS 3-year class with depreciation rates of 33.33% for the first year, 44.45% for the second year, 14.81% for the third year, and 7.41% for the fourth year. SMC plans to use the new machinery for four years and it is expected to have a salvage value of $75,000 after four years of use SMC expects the new machinery to generate sales of 1,500 units in the first year. Unit growth is expected to be 4% after the first year. The company estimates that the new product will sell for $225 per unit in the first year with a cost of $150 per unit, excluding depreciation Management projects that both the sale price and the cost per unit will increase by 3% per year due to inflation. Net working capital is projected to be 15% of next year's sales. The firm's marginal tax rate is 30%. SMC's WACC Jane Jefferson, a recent MBA graduate of Columbia University, is conducting the capital budgeting analysis for the project. The company hired her only a few weeks ago as the head of the newly formed Capital Budgeting Department. In order to evaluate the feasibility of the investment in the new system, her first task is to estimate SMC's WACC. She plans to use the financial data in Exhibit 1 to estimate the WACC. Prior to evaluating the project, the following conversation took place between Jane Jefferson and Fred Black, the CEO of the company, is a Princeton graduate with a major in financial economics and long years of administrative experience. Jefferson: It may be difficult to estimate the cost of borrowing in the current recessionary environment. Black: We can determine the yield to maturity (YTM) on our outstanding bonds by using their current market prices. We can assume that we will be able to issue additional bonds with this YTM as the cost of borrowing. We should be able to place the new bonds without any flotation costs. Therefore, we can assume no flotation costs in our calculations. We can re-examine the feasibility of the project later before raising funds by using sensitivity analysis to assess the impact of possible changes in interest rates on the net present value of the project. Jefferson: Do you think the company's current market value capital structure is optimal? Can we use the current percentages of the capital components as weights in the calculation of the company's WACC? Black: Yes, I believe that the company's current market value capital structure of 35% debt, 15% preferred stock and 50% equity is optimal. We have about $80,000 in retained earnings this year, which is also available in cash. We should be able to use this year's retained earnings to finance part of the equity financing required for the project. However, we will have to issue some new common shares for the remainder of the necessary equity financing. We can assume a flotation cost of about 7% for the new common shares and 4% for preferred shares. Jefferson: There are three basic methods of calculating a firm's cost of equity when retained earnings are used as equity capital: 1) the capital asset pricing method (CAPM); 2) the discounted cash flow (DCF) approach; and, 3) the bond-yield-plus-risk-premium method. Which of these methods should we use in the calculation of our cost of retained earnings