Bonds - The Memory Company has 10,000 bonds outstanding ($1000 face value). The bonds are selling at 101$ of face value, have a 7% coupon rate, pay interest annually, and mature in 9 years.
Preferred shares - There are 500,000 shares of 8% preferred stock ($100 stated value) outstanding with a current market price of $91 a share.
Common shares - In addition, there are 1.25 million share of common stock outstanding with a market price of $63 a share and a beta of .97. The common stock paid a total of $1.20 in dividends last year and experts to increase those dividends by 3% annually.
Other - The firm's marginal tax rate is 35%. The overall stock market is yielding 11% and the Treasury bill rate is 3.5%.
a. What is the cost of financing using preferred stock?
b. What is the cost of equity based on the dividend growth model? What is the cost of equity based on the security market line? Which is more reasonable?
This solution includes the computation for cost of preferred and common equity.