Northwest Utility Company faces Increasing needs for capital. Fortunately. It has an Aa3 credit rating. The corporate tax rate is 30 percent. Northwest's treasurer is trying to determine the corporation's current weighted average cost of capital in order to assess the profitability of capital budgeting projects. Historically, the corporation's earnings and dividends per share have Increased about 9.6 percent annually and this should continue the future. Northwest's common stock is selling at $71 per share, and the company will pay a $8.20 per share dividend (D,): The company's $110 preferred stock has been yielding 8 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $6.00 for preferred stock. The company's optimum capital structure is 50 percent debt, 25 percent preferred stock, and 25 percent common equity in the form retained earnings. Refer to the following table on bond Issues for comparative yields on bonds of equal risk to Northwest Data on Bond Issues Moody's Yield to Issue Rating Price Maturity Utilities: Pacific Electric Power --7 1/4 2033 Aa2 $930.18 8.88% Southwest Bell--7 3/8 2035 Aa3 898.25 8.66 Virginia Power & Light--8 1/2 2032 A2 960.66 8.66 Industrials: Issac & Johnson--6 3/4 2033 Aaa 870.24 8.55% Wholesale Department Stores--7 1/8 2033 A2 930.92 8.45 Hotel Corporation--10 2035 B2 1,070.10 9.77 a. Compute the cost of debt. K
Northwest Utility Company faces Increasing needs for capital. Fortunately. It has an Aa3 credit rating. The corporate tax rate is 30 percent. Northwest's treasurer is trying to determine the corporation's current weighted average cost of capital in order to assess the profitability of capital budgeting projects. Historically, the corporation's earnings and dividends per share have Increased about 9.6 percent annually and this should continue the future. Northwest's common stock is selling at $71 per share, and the company will pay a $8.20 per share dividend (D,): The company's $110 preferred stock has been yielding 8 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $6.00 for preferred stock. The company's optimum capital structure is 50 percent debt, 25 percent preferred stock, and 25 percent common equity in the form retained earnings. Refer to the following table on bond Issues for comparative yields on bonds of equal risk to Northwest Data on Bond Issues Moody's Yield to Issue Rating Price Maturity Utilities: Pacific Electric Power --7 1/4 2033 Aa2 $930.18 8.88% Southwest Bell--7 3/8 2035 Aa3 898.25 8.66 Virginia Power & Light--8 1/2 2032 A2 960.66 8.66 Industrials: Issac & Johnson--6 3/4 2033 Aaa 870.24 8.55% Wholesale Department Stores--7 1/8 2033 A2 930.92 8.45 Hotel Corporation--10 2035 B2 1,070.10 9.77 a. Compute the cost of debt. K
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:Northwest Utility Company faces Increasing needs for capital. Fortunately. It has an Aa3 credit rating. The corporate tax rate is 30
percent. Northwest's treasurer is trying to determine the corporation's current weighted average cost of capital in order to assess the
profitability of capital budgeting projects.
Historically, the corporation's earnings and dividends per share have Increased about 9.6 percent annually and this should continue in
the future. Northwest's common stock is selling at $71 per share, and the company will pay a $8.20 per share dividend (D₁);
The company's $110 preferred stock has been yielding 8 percent in the current market. Flotation costs for the company have been
estimated by its investment banker to be $6.00 for preferred stock.
The company's optimum capital structure is 50 percent debt, 25 percent preferred stock, and 25 percent common equity in the form of
retained earnings. Refer to the following table on bond Issues for comparative yields on bonds of equal risk to Northwest.
Issue
Utilities:
Data on Bond Issues
Moody's
Rating
Price
Yield to
Maturity
444 448
Aa2
$930.18
8.88%
Aa3
898.25
8.66
960.66
8.66
Aaa
870.24
8.55%
930.92
8.45
1,070.10
9.77
Pacific Electric Power 7 1/4 2033
Southwest Bell--7 3/8 2035
Virginia Power & Light--8 1/2 2032
Industrials:
Issac & Johnson--6 3/4 2033
Wholesale Department Stores--7 1/8 2033
Hotel Corporation--10 2035
a. Compute the cost of debt. Ka
Note: Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.
Cost of debt
%
b. Compute the cost of preferred stock, Kp.
Note: Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.
Cost of preferred stock
%
c. Compute the cost of common equity in the form of retained earnings, K...
Note: Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.
Cost of common equity
%
d. Calculate the weighted cost of each source of capital and the weighted average cost of capital.
Note: Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.
Debt
Preferred stock
Common equity
Weighted average cost of capital
Weighted Cost
%
%
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