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The preferred stock is selling at $90 per share and pays a dividend of $8.50 per share. The corporate tax rate is 20 percent. The flotation cost is 2 percent of the selling price for preferred stock. The optimum capital structure for the firm is 40 percent debt, 30 percent preferred stock, and 30 percent common equity in the form of retained earnings.
Required:
1. In Excel, compute the cost of capital for the individual components in the capital structure, and then calculate the weighted average cost of capital.
2. Prepare a brief summary to Ms. M explaining the limitations of using a weighted average cost of capital calculated in this manner. (10 marks)
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