9. Calculate the after-tax cost of preferred stock for Bozeman-Western Airlines, Inc., which is planning to tell $10 million of $8.50 cumulative preferred stock to the public at a price of $50 a share. The company has a marginal tax rate of 40 percent.
The Ewing Distribution Company is planning a $100 million expansion of its chain of discount service stations to several neighboring states. This expansion will be financed, in part, with debt issued with a coupon interest rate of 15%. The bonds have a 10-year maturity and a $1,000 face value, and they will be sold to net Ewing $980 after issue costs. Ewing’s marginal tax rate is 40%.
Preferred stock will pay a $12.90 dividend and the company will sell the shares for $90 and net $75. Ewing’s common stock pays a dividend of $2.55 per share. The current market price per share is $16, and new shares can be sold to net $12 per share. Ewing’s dividends are $2.55 this year and were $2.03 three years ago. The current risk-free rate is 6% and the market’s estimated rate of return is 18%. Ewing’s estimated beta is 1.5. Ewing expects to have $25 million of retained earnings available to finance the expansion.
Ewing’s capital structure (mil)
Preferred Stock 5
Common equity 70
(7)10. Compute the after tax cost of debt:
(7)11. Compute the cost of retained earnings: Discounted cash flow
(7)12. Compute the cost of retained earnings: CAPM
(7) 13. Compute the cost of new equity. (See Technical note for computation of new (external) equity.
(7) 14. Compute the weighted average cost of capital assuming: Retained earnings (Use the cost of retained earnings value from problem 11)
(7) 15. Compute the weighted average cost of capital assuming: Cost of new equity.