Question
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 6.4 percent annually and this should continue in the future. Northwests common stock is selling at $73 per share, and the company will pay a $4.60 per share dividend (D1). The companys $114 preferred stock has been yielding 10 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $8.00 for preferred stock.
The companys optimum capital structure is 60 percent debt, 25 percent preferred stock, and 15 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 | $ | 940.18 | 8.35 | % | |
Pacific bell7 3/8 2025 | Aa3 | 900.25 | 8.88 | |||
Pennsylvania power & light8 1/2 2022 | A2 | 970.66 | 8.88 | |||
Industrials: | ||||||
Johnson & Johnson6 3/4 2023 | Aaa | 890.24 | 8.66 | % | ||
Dillards Department Stores7 1/8 2023 | A2 | 950.92 | 8.66 | |||
Marriott Corp.10 2015 | B2 | 1,080.10 | 9.55 | |||
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.)
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