XYZ Corporation is interested in measuring the cost of each specific type of capital as well as the weighted average cost of capital. The firm pays tax at 20%. The firm capital structure consists of Long term debt 20%, preferred stock 30% and Common equity 50%.

Following data is available:

Debt: The firm can raise debt by selling $ 1000 par value, 5% coupon interest rate, 20 years bonds on which annual interest payments will be made. To sell the issue, an average discount of $30 per bond would have to be given. The firm also must pay flotation costs of $30 per bond.

Preferred stock: the firm can sell 6% preferred stock at its $ 100 per share par value. The cost of issuing and selling the preferred stock is expected to be $ 6 per share. Preferred stock can be sold under these terms.

Common stock: the firms; common stock is currently selling for $ 100 per share. The firm expects to pay cash dividends of $ 5 per share next year. The firms dividends have been growing an annual rate of 3%, and this growth is expected to continue into the future. The stock must be underpriced by $ 4 per share, and floatation costs are expected to amount to $ 3 per share. The firm can sell new common stock under these terms.

Required:

1. Calculate the cost of each source of finance.
2. Calculate the firms weighted average cost of capital using the capital weights given in the question.

Briefly explain why is the cost of financing a project with retained earnings less than the cost of financing it with a new issue of common stock?