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Northwest Utility Company faces increasing needs for capital. Fortunately, it has an Aa3 credit rating. The corporate tax rate is 40 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 8.2 percent annually and this should continue in the future. Northwest’s common stock is selling at $64 per share, and the company will pay a $6.50 per share dividend (D1). The company’s $96 preferred stock has been yielding 8 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $6 for preferred stock. The company’s optimum capital structure is 55 percent debt, 20 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 $ 895.18 8.74 % Pacific Bell––7 3/8 2025 Aa3 891.25 8.73 Pennsylvania Power & Light––8 1/2 2022 A2 970.66 8.77 Industrials: Johnson & Johnson––6 3/4 2023 Aaa 880.24 8.55 % Dillard’s Department Stores––7 1/8 2023 A2 960.92 8.22 Marriott Corp.––10 2015 B2 1,035.10 9.77 a. Compute the cost of debt, Kd (use the accompanying table—relate to the utility bond credit rating for yield) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of debt % b. Compute the cost of preferred stock, Kp. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of preferred stock % c. Compute the cost of common equity in the form of retained earnings, Ke. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Cost of common equity % d. Calculate the weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Weighted Cost Debt (Kd) % Preferred stock (Kp) Common equity (Ke) Weighted average cost of capital (Ka) %
Some advocates of behavioural finance agree with efficient market advocates that indexing is the optimal investment strategy for most investors. But their reasons for this conclusion differ greatly. Compare and contrast the rationale for indexing acc..
Nonconstant Growth Valuation A company currently pays a dividend of $4 per share (D0 = $4). It is estimated that the company's dividend will grow at a rate of 23% per year for the next 2 years, then at a constant rate of 8% thereafter. What is your e..
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What is the expected dividend to be paid in 3 years if yesterday's dividend was $6.00, dividends are expected to grow at a constant 6% annual rate, and the firm has a 10% expected return?
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The Joseph Company has a stock issue that pays a fixed dividend of $3.00 per share annually. Investors believe the nominal risk-free rate is 4 percent and that this stock should have a risk premium of 6 percent. What should be the value of this stock..
Can a trader earn covered interest arbitrage profits? If not, explain why not. If possible, determine what the likely directional impact on each rate would be if arbitrageurs took advantage of the profit potential.
Which of the following is not considered a relevant cash flow when deter- mining incremental cash flows for a new project?
You are considering an investment in Keller Corp's stock, which is expected to pay a dividend of $1.50 a share at the end of the year (D1 = $1.50) has a beta of 0.9. The risk-free rate is 3.6%, and the market risk premium is 4.0%. Keller currently se..
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