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Question: Gumball Corporation has the following capital structure that it wishes to maintain in the future:
Debt 25%
Preferred shares 20%
Common stock 40%
Retained earnings 15%
New debt financing is available in the form of 20-year, 12- percent bonds that can be sold at face value, and issuing and underwriting expenses can be ignored. New preferred shares would net the company $28 per share with a dividend of $2.40 per share. Common shares could be sold to the public at $8 per share, with 4-percent issuing costs (after taxes). The firm has a beta of 0.6, the current yield on long-term government bonds is 8.25 percent, and the yield on the market portfolio is expected to be 15 percent. The firm's tax rate is 40 percent.
(a) Compute Gumball's weighted average cost of capital.
(b) If $ 1 0,000,000 are provided through depreciation this year, what is the appropriate cost of such funds? Briefly discuss.
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