Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 30 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 5.8 percent annually and this should continue in the future. Northwests common stock is selling at $83 per share, and the company will pay a $5.40 per share dividend (D₁). The companys $134 preferred stock has been yielding 8 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $5.00 for preferred stock.

The companys optimal capital structure is 40 percent debt, 10 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.

a. Compute the cost of debt, K_d (use the accompanying tablerelate to the utility bond credit rating for yield.)

b. Compute the cost of preferred stock, K_p.

c. Compute the cost of common equity in the form of retained earnings, K_e.

d. Calculate the weighted cost of each source of capital and the weighted average cost of capital.

Data on Bond Issues Moody's Rating Price Yield to Maturity Issue Utilities Southwest electric power-7 1/4 2023 Pacific bel7 3/8 2025 Pennsylvania power & light--8 1/2 2022 Industrials Johnson & Johnson--6 3/4 2023 Dillard's Department Stores-7 3/8 2023 Marriott Corp.-10 2015 Aa2 $ 990.18 Aa3 A2 910.25 985.66 8.6496 8.93 8.88 Aaa A2 B2 900.24 970.92 1,130.10 8.55 9.44