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 8.3 percent annually and this should continue in the future. Northwests common stock is selling at $80 per share, and the company will pay a $7.30 per share dividend (D₁). The companys $128 preferred stock has been yielding 5 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 optimum capital structure is 40 percent debt, 15 percent preferred stock, and 45 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	$	975.18		8.34	%
Pacific bell7 3/8 2025	Aa3		907.25		8.63
Pennsylvania power & light8 1/2 2022	A2		970.66		8.55
Industrials:
Johnson & Johnson6 3/4 2023	Aaa		870.24		8.66	%
Dillards Department Stores7 1/8 2023	A2		940.92		8.33
Marriott Corp.10 2015	B2		1,115.10		9.55

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