Question

Northwest Utility Company faces increasing needs for capital, Fortunately, it has an Aa3 credit rating. The corporate tax rate is 35 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 4.6 percent annually and this should continue in the future. Northwest's common stock is selling at $69 per share, and the company will pay a $6.20 per share dividend (1) The company's $106 preferred stock has been yielding 6 percent in the current market Flotation costs for the company have been estimated by its investment banker to be $4.00 for preferred stock at debt, 10 percent preferred stock, and 55 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 Price Yield to Maturity $ 920.18 Data on Bond Issues Moody's Issue Rating Utilities: Southwest electric power-7 1/4 A7 2023 Pacific bell--7 3/8 2025 Aa3 Pennsylvania power & light-8 1/2 2022 Industrials: Johnson & Johnson--6 3/4 2023 Aaa Dillard's Department Stores --7 A2 1/8 2023 Marriott Corp.--10 2015 896.25 8.66% 8.44 8.45 995.66 850.24 910.92 1,060.10 8.35% 8.88 9.55

Answer 1

solution: a) 5.49% Kd = Yield *(1-tax) 0.0844*(1-0.35) b) Dp=106*6% 6.36 6.24% Kp=DP/(P-F) 6.36/(106-4) 13.59% Ke=(D1/PO)+g (6.2/69)+0.046 d) WACC 16 Debt Preferred stock Common equity Weighted average cost of capital after tax cost weight weighted cost c=a*b 5.49% 0.35 1.92% 6.24% 0.10 0.62% 13.59% 0.55 7.47% 10.02%