Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 35 percent. Northwest's treasurer is trying to determine the corporation's current weighted average cost of capital in order to assess the profitability of capital budgeting projects. Historically, the corporation's earnings and dividends per share have increased about 9.3 percent annually and this should continue in the future. Northwest's common stock is selling at $81 per share, and the company will pay a $8.30 per share dividend (D1). The company's $130 preferred stock has been yielding 6 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $6.00 for preferred stock. The company's optimum capital structure is 30 percent debt, 20 percent preferred stock, and 50 percent common equity in the form of retained earnings. Refer to the following table on bond issues for comparative yields on bonds of equal risk to Northwest. Data on Bond Issues Issue Moody's Rating Price Yield to Maturity Utilities: Southwest electric power--7 1/4 2023 Pacific bell--7 3/8 2025 Aa2 $ 980.18 8.44% Aa3 908.25 8.73 Pennsylvania power & light--8 1/2 2022 A2 975.66 8.66 Industrials: Johnson & Johnson--6 3/4 2023 Aaa 880.24 Dillard's Department Stores--7 1/8 2023 A2 Marriott Corp.--10 2015 B2 950.92 1,120.10 8.78% 8.22 9.99 a. Compute the cost of debt, Kd. (Use the accompanying table-relate to the utility bond credit rating for yield.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of debt % b. Compute the cost of preferred stock, Kp. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of preferred stock % c. Compute the cost of common equity in the form of retained earnings, Ke. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of common equity d. Calculate the weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Debt Preferred stock Common equity Weighted average cost of capital Weighted Cost % % Delta Corporation has the following capital structure: Debt (Kd) Preferred stock (Kp) Common equity (Ke) (retained earnings) Weighted average cost of capital (Ka) Cost Weighted (aftertax) Weights Cost 10.1% 20% 2.02% 11.2 15 1.68 8.1 65 5.27 8.97% a. If the firm has $39 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").) Capital structure size (X) million b. The 10.1 percent cost of debt referred to earlier applies only to the first $13 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").) Capital structure size (Z) million The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan's current capital structure calls for 45 percent debt, 15 percent preferred stock, and 40 percent common equity. Initially, common equity will be in the form of retained earnings (Ke) and then new common stock (Kn). The costs of the various sources of financing are as follows: debt (after-tax), 5.6 percent; preferred stock, 9 percent; retained earnings, 12 percent; and new common stock, 13.2 percent. a. What is the initial weighted average cost of capital? (Include debt, preferred stock, and common equity in the form of retained earnings, Ke) (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Debt Preferred stock Common equity Weighted average cost of capital Weighted Cost % % b. If the firm has $12 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").) Capital structure size (X) million c. What will the marginal cost of capital be immediately after that point? (Equity will remain at 40 percent of the capital structure, but will all be in the form of new common stock, K.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Marginal cost of capital % d. The 5.6 percent cost of debt referred to earlier applies only to the first $18 million of debt. After that, the cost of debt will be 7.2 percent. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").) Capital structure size (Z) million e. What will the marginal cost of capital be immediately after that point? (Consider the facts in both parts cand d.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Marginal cost of capital % Eaton Electronic Company's treasurer uses both the capital asset pricing model and the dividend valuation model to compute the cost of common equity (also referred to as the required rate of return for common equity). Assume: Rf 5% Km 10% D1 Po g 1.2 $0.80 $ 20 7% a. Compute Ki (required rate of return on common equity based on the capital asset pricing model). (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Ki % b. Compute Ke (required rate of return on common equity based on the dividend valuation model). (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Ke %