On January 1 the total market value of DOS Company was $50 million. During the year, the company plans to raise and invest, $10 million in new assets. The firm's present market value, optimal capital structure is $10 million debt and $40 million equity. Up to $1 million in new bonds can be sold for $975 each if the maturity is 10 years, the face value is $1000 and the annually paid coupon rate is 11%. Selling any bonds beyond that point will raise only $950 each. Assume that there is no short-term debt. The common stock is currently selling at $45 per share and can be sold to net the company $43 a share after flotation costs, The beta of the firm is 1.5 and the risk-free rate is 8% while the return on the market is 12%. The dividend is $3.38 to be paid next year, and the firm has an annual expected growth rate of 7.5% which is expected to be continuous for the foreseeable future. The bond yields plus risk premium approach assumes that stock earns at least 4% more than the initial rate on debt issued by the company. Retained earnings are projected to be $5 million and the marginal tax rate is 40%.

a. How much of the capital budget must be financed by common equity to maintain the optimal capital structure? How much of the new funds are generated by: New debt? New stock?

b. Calculate the two costs of Debt.

c. Estimate the current cost of equity by taking an average of the three different methods of estimation.