Question

Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 40 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 8.2 percent annually and this should continue in the future. Northwest’s common stock is selling at $64 per share, and the company will pay a $6.50 per share dividend (D1).
The company’s $96 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 55 percent debt, 20 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.


Compute the answers to the following questions from the information given.
a. Cost of debt, Kd (use the accompanying table––relate to the utility bond credit rating for yield)
b. Cost of preferred stock, Kp
c. Cost of common equity in the form of retained earnings, Ke
d. Weighted average cost ofcapital


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  • CreatedOctober 14, 2014
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