Pacific Intermountain Utilities Company has a present capital structur

QUESTION

Pacific Intermountain Utilities Company has a present capital structure (which the company feels is optimal) of 50 percent long-term debt, 10 percent preferred stock, and 40 percent common equity. For the coming year, the company has determined that its optimal capital budget can be externally financed with $70 million of 10 percent first-mortgage bonds sold at par and $14 million of preferred stock costing the company 11 percent. The remainder of the capital budget will be financed with retained earnings. The companys common stock is presently selling at $25 a share, and next years common dividend, D1, is expected to be $2 a share. The company has 25 million common shares outstanding. Next years net income available to common stock (including net income from next years capital budget) is expected to be $106 million. The companys past annual growth rate in dividends and earnings has been 6 percent. However, a 5 percent annual growth in earnings and dividends is expected for the foreseeable future. The companys marginal tax rate is 40 percent. Calculate the companys weighted cost of capital for the coming year.
Solution: Cost of debt is 10% Weight of debt is 50% Tax rate is 40% Cost of preferred is 11% Weight of preferred is 10% Cost of equity will be found out using CAPM Weight of equity is 40% As per CAPM, Cost of equity = (D1/P0) + g, where D1 is dividend next year,P0 is current price and g is expected growth rate Cost of equity = (2/25) + 5% Cost of equity = 8%+5% Cost¦

of equity = 13% WACC = weight of debt x cost of debt post tax + weight of preferred x cost of preferred + weight of common stock x cost of common stock WACC = (50% x 10% x 1-40%) + (10% x 11%) + (40% x 13%) WACC = 3% + 1.1% + 5.2% WACC = 9.3%

ANSWER:

CLICK REQUEST FOR  AN EXPERT SOLUTION