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ABC wishes to estimate its cost of capital.

The problem:
ABC wishes to estimate its cost of capital. The current capital structure is 40% debt, 10% preferred, and 50% common equity. The debt's ytm is 8.3%. Preferred has a par of $70, and 8% dividend, and sells for $76. Beta is 1.05. The risk free rate is 4%, and the market return is 11.4%. The tax rate is 40%.
1)What are the pretax component costs of capital?
2)Which one should be used for investment decisions?
3)What is the WACC before and after taxes?

Please explain in details the steps of solving this problem.

Solution Preview

The problem:
ABC wishes to estimate its cost of capital. The current capital structure is 40% debt,
10% preferred, and 50% common equity. The debt's ytm is 8.3%. Preferred has a par
of $70, and 8% dividend, and sells for $76. Beta is 1.05. The risk free rate is 4%, and
the market return is 11.4%. The tax rate is 40%. ...

Solution Summary

This solution is comprised of a detailed explanation to answer what are the pretax component costs of capital.

$2.19