1.      a firm has determined its optimal capital structure, which is

1.      A firm has determined its optimal capital structure, which is composed of the following sources and target market value proportions:

 

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Source of Capital

 Long-term debt             30%

 Preferred stock            5%

 Common stock equity  65%

 

Debt: The firm can sell a 20-year, $1,000 par value, 9 percent bond for $980. A flotation cost of 2 percent of the face value would be required in addition to the discount of $20.

Preferred Stock: The firm has determined it can issue preferred stock at $65 per share par value. The stock will pay an $8.00 annual dividend. The cost of issuing and selling the stock is $3 per share. Common Stock: The firm’s common stock is currently selling for $40 per share. The dividend expected to be paid at the end of the coming year is $5.07. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.45. It is expected that to sell, a new common stock issue must be underpriced at $1 per share and the firm must pay $1 per share in flotation costs. Additionally, the firm’s marginal tax rate is 40 percent.

 

Calculate the firm’s weighted average cost of capital assuming the firm has exhausted all retained earnings. 

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