Answer Happy

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 6.6 percent annually and this should
continue in the future. Northwest’s common stock is selling at $67
per share, and the company will pay a $4.20 per share dividend
(D1).

The company’s $102 preferred stock has been yielding 4 percent in
the current market. Flotation costs for the company have been
estimated by its investment banker to be $3.00 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.
a. Compute the cost of
debt, Kd. (Use the accompanying
table—relate to the utility bond credit rating for
yield.) (Do not round intermediate calculations. Input
your answer as a percent rounded to 2 decimal places.)
b. Compute the cost of preferred
stock, Kp. (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, Ke. (Do not round
intermediate calculations. Input your answer as a percent rounded
to 2 decimal places.)
d. Calculate the weighted cost of each
source of capital and the weighted average cost of
capital. (Do not round intermediate calculations.
Input your answers as a percent rounded to 2 decimal places.)