Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 40 percent. Northwests treasurer is

Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 40 percent. Northwests treasurer is trying to determine the corporations current weighted average cost of capital in order to assess the profitability of capital budgeting projects. Historically, the corporations earnings and dividends per share have increased about 9.4 percent annually and this should continue in the future. Northwests common stock is selling at $76 per share, and the company will pay a $9.60 per share dividend (D1). The companys $120 preferred stock has been yielding 9 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $4.00 for preferred stock. The companys optimum capital structure is 40 percent debt, 20 percent preferred stock, and 40 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 Moodys Rating Price Yield to Maturity
Utilities:
Southwest electric power7 1/4 2023 Aa2 $ 955.18 8.66 %
Pacific bell7 3/8 2025 Aa3 903.25 8.33
Pennsylvania power & light8 1/2 2022 A2 985.66 8.66
Industrials:
Johnson & Johnson6 3/4 2023 Aaa 830.24 8.34 %
Dillards Department Stores7 1/8 2023 A2 980.92 8.90
Marriott Corp.10 2015 B2 1,095.10 9.66

a. Compute the cost of debt, Kd. (Use the accompanying tablerelate to the utility bond credit rating for yield.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

b. Compute the cost of preferred stock, Kp. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

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.)

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, WACC]

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Audit And Business Performance

Authors: BELAMKADDAM HAMZA

1st Edition

6205444062, 978-6205444061

More Books

Students also viewed these Accounting questions