Practice Problem #3 Show All your work

Watson Company wants to raise capital for a planned expansion into a new market.The firm has 1 million shares of common equity with a par value (book value) of $1 and retained earnings of $30 million, its shares have a market value of $50 per share.It also has debt with a par or book value of $20 million, and 500,000 preferred shares outstanding.

You have collected the following information on Watson Company:

Watson has just paid a dividend of $3 and has expected dividend growth of 4.8% per year

Watson has a $20 million debt issue outstanding ($1000 par) with a 6% coupon rate. The debt has semi annual coupons and matures in five years. The bonds are selling at 95% of par

The company has a 40% tax rate

Watson also has 500,000 preferred shares outstanding. They are trading at $65 per share.They have a $75 par value and a dividend of $4 due in one year

The equity investors of Watson have a beta of 1.3. The T Bill rate is 5%, the market risk premium is 5%, and the return on the market is 10%.

A)What is your estimate of the average cost of equity capital?

Use the both of the two methods we have learned.

B)What is the after tax cost of debt?

C)What is the cost of preferred capital?

D)What is the market value weight of the company's common equity capital?

E)What is the market value weight of the company's cost of debt capital?

F)What is the market value weight of the company's cost of preferred equity

capital?

G) What is the Weighted Average Cost of Capital (WACC) for Watson Company?