Reference no: EM13913141

Cost of capital

The Simpson Corporation has the following items:

Partial Balance sheet for Simpson

            Liabilities and Equity

A/P                                           525,000

Short term notes payable        1,200,000

Total Current Liabilities         1,725,000

Bonds                                      2,000,000

Total Liabilities                       3,725,000

Preferred Stock                          500,000

Common Stock                        800,000

Retained Earnings                   1,700,000

Total Liabilities and Equity    6,725,000

There are 2,000 bonds outstanding at a market price of $1090 per bond. The bonds mature in 17 years and have a coupon payment of $70 on the $1,000 face value of the bond.

There are 26,000shares of preferred stock outstanding at a market price of $20 per share with a $2.20 dividend. The firm expects a flotation cost of 10% on new preferred stock.

There are 86,000 shares of common stock outstanding. The market price of common stock is $30 per share with the last dividend paid (D0) of $3.00 per share the firm has an expected growth rate of 4% per year on earnings. Flotation cost on new common is 8% of sales price per share.

The firm has a marginal tax rate of 30%.

The firm estimates that it will generate net income of $600,000 for the year and will retain 70%of its earnings.

Requirements:

a. Find the 3 weights to be used to determine the cost of capital (Debt, Preferred, and Common equity weights) using market value and book values.

b. Find the component costs (%) for bonds (rd), preferred stock(rp), retained earnings(rs) and new issue common stock. (re)...

c. Find the retained earnings (Equity) break point.

d. Determine the weighted average cost of capital before and after the breakpoint using both market value and book value weights.