Question

A Cost of Capital Problem

You collect the following information on the debt andequity components of Walkure Corporation’s capital structure. Thecorporation believes it has an optimal capital structure and willuse the current capital structure to calculate its cost ofcapital.

Capital Structure	Book	Market	Term to	Current	Par
Components	Value	Value	Maturity	Price	Value
	[In millions]	[In millions]	In Years
4.65% Senior Debentures	$ 31.45	$30.19	5	$960.00	$1,000
6.35% Senior Debentures	102.72	100.66	11	$980.00	$1,000
9.10% Subordinated Debentures	82.32	88.08	14	$1,070.00	$1,000
8.40% Preferred Stock	20.98	25.17	perpetual	$30.00	$25
Common Equity	190.00	259.19		$32.00	$1
Totals	$424.47	$503.29

The firm has a marginal income tax rate of 35% andflotation costs currently estimated at 2% on debt issues and 5% onequity issues. The company expects to pay a dividend of $0.40 pershare on its common next year and growth is expected to be 6.5%annually in the future.

Assuming no new common stock will be issued to thepublic -- i.e. all new common equity will be internally generated –calculate effective costs and the weighted-average cost of capitalfor the firm based on the current capital structure, which isassumed to be optimal.

A. What is the Effective Costof the 8.40% Preferred Stock?

a. 8.40%

b. 7.37%

c. 6.91%

d. 5.46%

e. 4.55%%

B. What is the Effective Costof the Internal Common Stock?

a. 7.75%

b. 5.47%

c. 5.30%

d. 5.04%

e. 5.00%