Reference no: EM132544252

During the last few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program proposed by the marketing department. Assume that you are an assistance to Leigh Jones, the financial Vice President.

Your task is to estimate Harry Davis' cost of capital, based on the following:

• The firm's 8% coupon, semiannual payment, noncallable bonds, with 15 years left to maturity are currently trading at 1.09, but have face value of $5 million. New bonds, if issued, would incur 4% after-tax flotation costs.

• The current price of the firm's 6%, $25 par value, quarterly dividend, preferred stock is $20. After-tax flotation costs of 5% would be incurred on any new issue, but there are 100,000 preferred stock currently issued.

• The firm's common stock is currently trading at $50 per share. Its most recent dividend was $2 per share, which is expected to grow at a constant rate of 6%. The firm's beta is 1.2, the treasury costs of 2.5% would be incurred on any new issue, but there are 200,000 stock currently issued.

Required :

Question 1: Calculate the firm's cost of capital for both internal and external common equity financing, assuming 35% tax rate.