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The information technology group of ABC company has proposed a large expansion plan, and the company needs to determine its cost of capital before moving forward with the plan. You are an assistant to the financial vice president, Jerry Lehman, and your initial responsibility is to determine the cost of capital for the company. Lehman has given you some data that he thinks could be useful for this task. The company has a tax rate of 40%. The current value of ABCs bonds, which pay a 12% coupon annually and have 15 years until maturity, is $1,153.72 (to solve for the cost of debt, use the excel sheet rate function and provide the numbers of nper, pmt, pv, and fv of the bond along with cost of debt %). The company does not use short-term debt for long-term financing, and any new bonds issued would not have any flotation costs. Additionally, the company's perpetual preferred stock, which pays a 10% quarterly dividend and has a par value of $100.00, is currently valued at $111.10.

ABC's common stock is currently being sold for $50 per share. Its last dividend was $4.19 and is expected to grow at a constant annual rate of 5% in the foreseeable future. The company's beta is 1.2, the yield on T-bonds is 7%, and the market risk premium is estimated to be 6%. The company uses a risk premium of 4% for the bond-yield-plus-risk-premium approach. ABCs target capital structure is 30% debt, 10% preferred stock, and 60% common equity.

Required:

What is the market interest rate on ABCs debt and its component cost of debt?

What is the firms cost of preferred stock?

What is ABCs estimated cost of common equity using the CAPM approach?

What is the estimated cost of common equity using the DCF approach?

What is the bond-yield-plus-risk-premium estimate for ABCs cost of common equity?

What is your final estimate for cost of equity?

ABC estimates that if it issues new common stock, the flotation cost will be 15%. ABC

incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, considering the flotation cost?

What is ABCs overall, or weighted average, cost of capital (WACC)? Ignore flotation costs.

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