The following assumptions are used to determine the cost of capital.

Historically, the company has maintained a debt ratio is 50%.This ratio was used, because lowering the debt implies giving up the debt tax shield, and increasing it makes debt service a burden on the firm's cash flow.In addition, increasing the debt level may cause a reduced rating of the company's bonds.The marginal tax rate is 25%.All the numbers are expressed in today's dollars.The forecasted average inflation per year is 3.0%.

Cost of debt:

The company's bond rating is roughly at the high end of the A range.Surveying the debt market yielded the following information about the cost of debt for different rating levels:

Bond rating AA A BBB Interest cost range 5.5% ~ 6.5% 6.25% ~ 7.5% 7.5% ~ 9%

The company's current bonds have a yield to maturity of about 6.75%.

Cost of equity:

The current 10-year Treasury notes have a yield to maturity of 2.10% and the forecast for the S&P 500 market premium is 9.00%.The company's overall is 1.35.