Question:

As a financial analyst for National Engineering, you are required to estimate the cost of capital the firm should use in evaluating its heavy construction projects. The firm's balance sheet data and other information are listed below. Assume a 35% corporate tax rate.

a. What is your estimate? What assumptions must you make to calculate this estimate?

b. What qualifications to this estimate should you mention in your report when National applies this rate to its various projects?

Selected Balance Sheet Items

Bonds (see market data)

Preferred stock $ 400,000

Common Stock $ 800,000

Retained Earnings $2,000,000

Market Data

Market ValueYield

Bonds:

8%, 10-year $ 250,000 12%

12%, 15-year $1,000,000 15%

21%, 1-year $ 250,000 11%

Common stock:

Average dividend growth (5 years) = 10%

Current Dividend Yield = 7%

Price = $47.25

Shares = 100,000

Preferred stock:

$4.50 preferred dividend

Price = $22.50

Shares = 20,000