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Question - Calculate the weighted average cost of capital that is appropriate to use in evaluating this expansion program.
The Solo Company is considering a $300 million expansion of its entertainment business. The expansion project is of average risk for the firm. This expansion will be financed, in part, with bonds that would pay a coupon rate of 7% in order to be issued at par (assume issuing costs are zero). Solo's marginal tax rate is 40%.
Preferred stock will cost Solo 10%. Solo's common stock is expected to pay a dividend of $3 per share next year. The current market price per share is $25, and new shares can be sold to net $24 per share. Solo's dividends are expected to increase at an annual rate of 4% for the foreseeable future. Solo expects to have $57 million of retained earnings available to finance the expansion.
The firm's target capital structure is as follows:
Debt 35%
Preferred stock 10%
Common stock 55%
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