Brook’s Window Shields Inc. is trying to calculate its cost of capital for use in a...

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Finance

Brook’s Window Shields Inc. is trying to calculate its cost ofcapital for use in a capital budgeting decision. Mr. Glass, thevice-president of finance, has given you the following informationand has asked you to compute the weighted average cost ofcapital.
The company currently has outstanding a bond with a 9.2 percentcoupon rate and another bond with a 6.2 percent coupon rate. Thefirm has been informed by its investment banker that bonds of equalrisk and credit rating are now selling to yield 10.2percent.
The common stock has a price of $66 and an expected dividend(D₁) of $3.50 per share. The firm's historicalgrowth rate of earnings and dividends per share has been 5.2percent, but security analysts on Wall Street expect this growth toslow to 3 percent in future years.
The preferred stock is selling at $62 per share and carries adividend of $4.50 per share. The corporate tax rate is 40 percent.The flotation cost is 1.8 percent of the selling price forpreferred stock. The optimal capital structure is 20 percent debt,15 percent preferred stock, and 65 percent common equity in theform of retained earnings.
a. Compute the cost of capital for theindividual components in the capital structure. (Do notround intermediate calculations. Input your answers as a percentrounded to 2 decimal places.)

b. Calculate the weighted cost of each sourceof capital and the weighted average cost of capital. (Donot round intermediate calculations. Input your answers as apercent rounded to 2 decimal places.)

Answer & Explanation Solved by verified expert

3.6 Ratings (428 Votes)

a Proceeds from preferred equity price1flotation cost 621001860884 Cost of equity As per DDM Price Dividend in 1 yearcost of equity growth rate 66 35 Cost of equity 003 See Answer

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Transcribed Image Text

Brook’s Window Shields Inc. is trying to calculate its cost ofcapital for use in a capital budgeting decision. Mr. Glass, thevice-president of finance, has given you the following informationand has asked you to compute the weighted average cost ofcapital.The company currently has outstanding a bond with a 9.2 percentcoupon rate and another bond with a 6.2 percent coupon rate. Thefirm has been informed by its investment banker that bonds of equalrisk and credit rating are now selling to yield 10.2percent.The common stock has a price of $66 and an expected dividend(D1) of $3.50 per share. The firm's historicalgrowth rate of earnings and dividends per share has been 5.2percent, but security analysts on Wall Street expect this growth toslow to 3 percent in future years.The preferred stock is selling at $62 per share and carries adividend of $4.50 per share. The corporate tax rate is 40 percent.The flotation cost is 1.8 percent of the selling price forpreferred stock. The optimal capital structure is 20 percent debt,15 percent preferred stock, and 65 percent common equity in theform of retained earnings.a. Compute the cost of capital for theindividual components in the capital structure. (Do notround intermediate calculations. Input your answers as a percentrounded to 2 decimal places.) b. Calculate the weighted cost of each sourceof capital and the weighted average cost of capital. (Donot round intermediate calculations. Input your answers as apercent rounded to 2 decimal places.)