a. Compute the cost of debt, Kd. Note: Do not round intermediate calculations. Input your answer as a percent rounded to 2 decima 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 Cost of preferred stock % c. Compute the cost of common equity in the form of retained earnings, K
a. Compute the cost of debt, Kd. Note: Do not round intermediate calculations. Input your answer as a percent rounded to 2 decima 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 Cost of preferred stock % c. Compute the cost of common equity in the form of retained earnings, 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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The Return on Equity (RoE) is a measure of the profitability of a business concerning the funds by its stockholders/shareholders. ROE is a metric used generally to determine how well the company utilizes its funds provided by the equity shareholders.
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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 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 9.4 percent annually and this should continue in
the future. Northwest's common stock is selling at $76 per share, and the company will pay a $9.60 per share dividend (D₁)
The company's $120 preferred stock has been yielding 9 percent in the current market. Flotation costs for the company have been
estimated by its investment banker to be $4.00 for preferred stock.
The company's optimum capital structure is 40 percent debt, 20 percent preferred stock, and 40 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:
Pacific Electric Power -7 1/4 2033
Southwest Bell-7 3/8 2035
Data on Bond Issues
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
Cost of debt
Cost of preferred stock
%
Moody's
Rating
Aa2
Aa3
A2
%
Aaa
A2
82
Price
$ 955.18
903.25
985.66
830.24
980.92
1,095.10
a. Compute the cost of debt, Ka.
Note: Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.
Yield to
Maturity
8.66%
8.33
8.66
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.
c. Compute the cost of common equity in the form of retained earnings, K
8.34%
8.90
9.66
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