Problem #2

please provide the calculation method below

Valvano Publishing Company is trying to calculate its cost of capital for use in a capital budgeting

decision. Mr. Washburn, the vice-president of finance, has given you the following information and has

asked you to compute the weighted average cost of capital.

The company currently has outstanding a bond with an 6.5 percent coupon rate and a convertible bond

with a 4.5 percent rate. The firm has been informed by its investment dealer, Dean, Smith, and

Company, that bonds of equal risk and credit rating are now selling to yield 7.5 percent. The common

stock has a price of $74 and an expected dividend (D1) of $2.20 per share. The firm's historical growth

rate of earnings and dividends per share has been 9.2 percent, but security analysts on Bay Street

expect this growth to slow to 7 percent in the future years. The preferred stock is selling at $70 per

share and carries a dividend of $8.50 per share. The corporate tax rate is 30 percent. The flotation cost

are 3.3 percent of the selling price for preferred stock.

The optimum capital structure for the firm seems to be 40 percent debt, 10 percent preferred stock,

and 50 percent common equity in the form of retained earnings.

a) Compute the cost of capital for the individual components in the capital structure.

b) Calculate the weighted average cost of capital.