As a financial analyst for National Engineering, you are required to estimate the cost of capital the firm should use in evaluating its heavy construction projects. The firm’s balance sheet data and other information are listed below. Assume a 35% corporate tax rate.
a. What is your estimate? What assumptions must you make to calculate this estimate?
b. What qualifications to this estimate should you mention in your report when National applies this rate to its various projects?
Selected Balance Sheet Items Market Data
Market Value yield
Bonds (see market data) Bonds
Preferred stock $ 400,000 8%, 10-year $ 250,000 12%
Common Stock $ 800,000 12%, 15-year $1,000,000 15%
Retained Earnings $2,000,000 21%, 1-year $ 250,000 11%
Common Stock:
Average dividend growth (5 years) = 10%
Current Dividend Yield = 7%
Price = $47.25
Shares = 100,000
Preferred stock:
$4.50 preferred dividend
Price = $22.50
Shares = 20,000