(Weighted average cost of capital) Crypton Electronics has a capital structure consisting of 40% common stock and 60% debt. A debt issue of $1,000 par value, 6% bonds that mature in 15 years and pay annual interest will sell for $975. Common stock of the firm is currently selling for $30 per share and the firm expects to pay a $2.25 dividend next year. Dividends have grown at the rate of 5% per year and are expected to continue to do so for the foreseeable future. What is Crypton’s cost of capital where the firm’s tax rate is 30%?
14–24. (Weighted average cost of capital) Bane Industries has a capital structure consisting of 60% common stock and 40% debt. The firm’s investment banker has advised the firm that debt issued with a $1,000 par value, 8% coupon (interest paid semi-annually), maturing in 20 years can be sold today in the bond market for $1,100. Common stock of the firm is currently selling for $80 per share. The firm expects to pay a $2 dividend next year. Dividends have grown at the rate of 8% per year and are expected to continue to do so for the foreseeable future. What is Bane’s weighted average cost of capital where the firm faces a tax rate of 34%?
14–25. (Weighted average cost of capital) As a member of the Finance Department of Ranch Manufacturing, your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the firm’s present capital structure reflects the appropriate mix of capital sources for the firm, you have determined the market value of the firm’s capital structure as follows:
Source of Capital Market Values
Preferred stock $2,000,000
Common stock $6,000,000
To finance the purchase, Ranch Manufacturing will sell 10-year bonds paying 7% per year at the market price of $1,050. Preferred stock paying a $2.00 dividend can be sold for $25. Common stock for Ranch Manufacturing is currently selling for $55 per share and the firm paid a $3 dividend last year. Dividends are expected to continue growing at a rate of 5% per year into the indefinite future. If the firm’s tax rate is 30%, what discount rate should you use to evaluate the equipment purchase?
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