Company faces increasing needs for capital

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Reference no: EM132059505

Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 35 percent. Northwest’s treasurer is trying to determine the corporation’s current weighted average cost of capital in order to assess the profitability of capital budgeting projects. Historically, the corporation’s earnings and dividends per share have increased about 6.8 percent annually and this should continue in the future. Northwest’s common stock is selling at $84 per share, and the company will pay a $6.40 per share dividend (D1). The company’s $136 preferred stock has been yielding 9 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $6.00 for preferred stock. The company’s optimal capital structure is 50 percent debt, 25 percent preferred stock, and 25 percent common equity in the form of retained earnings. Refer to the following table on bond issues for comparative yields on bonds of equal risk to Northwest. Data on Bond Issues Issue Moody’s Rating Price Yield to Maturity Utilities: Southwest electric power––7 1/4 2023 Aa2 $ 995.18 8.74 % Pacific bell––7 3/8 2025 Aa3 911.25 9.22 Pennsylvania power & light––8 1/2 2022 A2 990.66 8.99 Industrials: Johnson & Johnson––6 3/4 2023 Aaa 910.24 8.33 % Dillard’s Department Stores––7 3/8 2023 A2 980.92 8.66 Marriott Corp.––10 2015 B2 1,135.10 9.55 a. Compute the cost of debt, Kd (use the accompanying table—relate to the utility bond credit rating for yield.)

Reference no: EM132059505

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