Question: Cost of capital Coleman Technologies is considering a main expansion program that has been proposed by the firm's information technology group. Before proceeding with the expansion, the company must estimate cost of capital. Suppose that you are an assistant to Jerry Lehman, the financial vice president. Your 1st task is to estimate Coleman's cost of capital. Lehman has provided you with the following data, which he believes may be relevant to your task.
[A] The company's tax rate is 40%.
[B] The current price of Coleman's 12% coupon, semiannual payment, no callable bonds with 15 years remaining to maturity is $1,153.72. Coleman does not use short-term interest bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost.
[C] The current price of the company's 10%, $100 par value, quarterly dividend, perpetual preferred stock is $111.10.
[D] Coleman's common stock is currently selling for $50 per share. Its last dividend (D_0) was $4.19, & dividends are expected to grow at a constant rate of 5% in the foreseeable future. Coleman's beta is 1.2, the yield on T-bonds is 7%, & the market risk premium is estimated to be 6%. For the bond-yield-plus-risk-premium approach, the firm uses a risk premium of 4%.
[E] Coleman's target capital structure is 30% debt, 10% preferred stock, & 60% common equity.
Describe why new common stock has a higher cost than retained earnings.