Question

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 proftability of capital budgeting projects. Historically, the corporation's eamings and dividends per share have increased about 7.2 percent annually and this should continue in the future. Northwest's common stock is selling at $62 per share, and the company will pay a $2.50 per share dividend (D1) The company's $92 preferred stock has been yielding 5 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $4.00 for preferred stock. The company's optimal capital structure is 30 percent debt, 20 percent preferred stock, and 50 percent common equity in the form of retained earnings. Refer to the following table on bond issues for comparative yiclds on bonds of equal risk to Northwest. Data on Bond Issues Mcody's Yield to Maturity Issue RatingPrica Utilities: Southwest electric power 71/4 2023 Pacific bell -7 318 2025 Pennsylvania power & light-81/2 2022 Aa2 Aa3 A2 S 885.18 889.25 980.66 8.54% 8.53 8.55 Johnson & Johnson 6 3/4 2023 Dillard's Department Stores-7 318 2023 Marriott Corp.-10 2015 Aaa A2 82 980.24 940.92 1,025.10 8.34% 8.66 9.75 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.) Cost of debt 4.98:% b. Compute the cost of preferred stock, Kp (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of preferred stock c. Compute the cost of common equity in the form of retained camings, K. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of common equity 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.) Weighted Cost Debt