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The Ewing Distribution Company is planning a $120 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 18 percent. The bonds have a 10-year maturity and a $1,000 face value, and they will be sold to net Ewing $978 after issue costs. Ewing's marginal tax rate is 40 percent.
Preferred stock will cost Ewing 15 percent after taxes. Ewing's common stock pays a dividend of $5 per share. The current market price per share is $16, and new shares can be sold to net $15 per share. Ewing's dividends are expected to increase at an annual rate of 6 percent for the foreseeable future. Ewing expects to have $30 million of retained earnings available to finance the expansion.
Ewing's target capital structure is as follows:
Debt40% Preferred stock 15 Common equity45 Calculate the weighted cost of capital that is appropriate to use in evaluating this expansion program.
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