GoodLife Publishing has been informed by its investment dealer, Karen Smith, and

Question

GoodLife Publishing has been informed by its investment dealer, Karen Smith, and Company, that bonds of equal risk and credit rating are now selling to yield 13 percent. The common stock has a price of $45 and an expected dividend (D1) of $2.52 per share. The firm's historical growth rate of earnings and dividends per share has been 11 percent. The preferred stock is selling at $50 per share and carries a dividend of $5.5 per share. The corporate tax rate is 34 percent.

The optimum capital structure for the firm seems to be 35 percent debt, 10 percent preferred stock, and 55 percent common equity.

Required: Compute the cost of capital for the individual components in the capital structure, and then calculate the weighted average cost of capital.  

Explanation / Answer

cost of equity = 2.52/45 + 11%

cost of debt = 13%*0.66

cost of preferred stock = 5.5/50

Weighted average cost of capital = 13.23%

Amount weight cost weight*cost equity 55 0.5500 16.600% 0.0913 debt 35 0.3500 8.58% 0.0300 preferred share 10 0.1000 11.00% 0.01

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