Questions:

The firm$$s marginal tax rate is $40\%.$

The current price of Coleman$$s $12\%$ coupon, semiannual payment, noncallable bonds with $15$ years remaining to maturity is $$1,153\mathrm{.}72.$ Coleman does not use short$-$term interest$-$bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost.

The current price of the firm$$s $10\%,$ $$100$ par value, quarterly dividend, perpetual preferred stock is $$113\mathrm{.}10.$ Coleman would incur flotation costs of $$2$ per share on a new issue.

Coleman$$s common stock is currently selling at $$50$ per share. Its last dividend $($D$0)$ was $$4\mathrm{.}19,$ and dividends are expected to grow at a constant rate of $5\%$ in the foreseeable future. Coleman$$s beta is $1\mathrm{.}2,$ the yield on Treasury bonds is $7\%,$ and the market risk premium is estimated to be $6\%.$ For the bond$-$yield$-$plus$-$risk$-$premium approach, the firm uses a four percentage$-$point risk premium.

Up to $$300,000$ of new common stock can be sold at a flotation cost of $15\%.$ Above $$300,000,$ the flotation cost would rise to $25\%.$

Coleman$$s target capital structure is $30\%$ long$-$term debt, $10\%$ preferred stock, and $60\%$ common equity.

The firm is forecasting retained earnings of $$300,000$ for the coming year.

To structure the task somewhat, Lehman has asked you to answer the following questions:

What is the market interest rate on Coleman$$s debt and its component cost of debt?

$(1)$What is the firm$$s cost of preferred stock?

$(2)$ Coleman$$s preferred stock is riskier to investors than its debt, yet the yield to investors is lower than the yield to maturity on the debt. Does this suggest that you have made a mistake? $($Hint: Think about taxes.$)$

$(1)$ What is Coleman$$s estimated cost of retained earnings using the CAPM approach?

$(2)$ What is the estimated cost of retained earnings using the discounted cash flow $($DCF$)$ approach?

$(3)$ What is the bond$-$yield$-$plus$-$risk$-$premium estimate for Coleman$$s cost of retained earnings?

$(4)$ What is your final estimate for rs$,$ Coleman$$s cost of retained earnings?

What is Coleman$$s cost for up to $$300,000$ of newly issued common stock, re$1?$ What happens to the cost of equity if Coleman sells more than $$300,000$ of new common stock?

$(1)$ What is Coleman$$s overall, or weighted average, cost of capital $($WACC$)$ when retained earnings are used as the equity component?

$(2)$ What is the WACC after retained earnings have been exhausted and Coleman uses up to $$300,000$ of new common stock with a $15\%$ flotation cost?

$(3)$ What is the WACC if more than $$300,000$ of new common equity is sold?

To structure the task somewhat, Lehman has asked you to answer the following questions:

a$.$ What is the market interest rate on Coleman$$s debt and its component cost of debt?

b$.(1)$ What is the firm$$s cost of preferred stock?

$(2)$ Coleman$$s preferred stock is riskier to investors than its debt, yet the yield to investors is lower

than the yield to maturity on the debt. Does this suggest that you have made a mistake? $($Hint:

Consider the taxation of interest income and dividend income received by investors.$)$

c$.(1)$ What is Coleman$$s estimated cost of retained earnings using the CAPM approach?

$(2)$ What is the estimated cost of retained earnings using the discounted cash flow $($DCF$)$ approach?

$(3)$ What is the bond$-$yield$-$plus$-$risk$-$premium estimate for Coleman$$s cost of retained earnings?

$(4)$ What is your final estimate for r s$,$ Coleman$$s cost of retained earnings?

d$.$ What is Coleman$$s cost for up to $$300,000$ of newly issued common stock, r e$1?$ What happens to the

cost of equity if Coleman sells more than $$300,000$ of new common stock?

e$.(1)$ What is Coleman$$s overall, or weighted average, cost of capital $($WACC$)$ when retained earnings

are used as the equity component?

$(2)$ What is the WACC after retained earnings have been exhausted and Coleman uses up to

$$300,000$ of new common stock with a $15\%$ flotation cost?

$(3)$ What is the WACC if more than $$300,000$ of new common equity is sold?