Case Scenario: Ramsey Data Systems is a large company with common stock listed on the New York Stock Exchange and bonds traded over-the counter. AS of the current blance sheet, it has three bond issues outstanding:
Expiration
$50 million of 9% series 2013
$100 million of 6% series 2010
$150 million of 4% series 2004
As the president of finance, I am planning to sell $150 million of bonds to replace the debt due to expire in 2004. Currently, the market yields on similar Baa bonds are 11.2%. Ramsey also has $60 million of 6.9% noncallable preferred stock outstanding, and I have no intentions of selling any preferred stock at any time in the future. The preferred stock is currently priced at $68 per share, and its dividend per share is $6.30.
While the company has had some very volatile earnings in the past, its dividends per share have had very stable growth rate experience of 8.5% and I expect this to continue. The expected dividend is $2.10 per share, and the common stock is selling for $60 per share. The company's investment banker has quoted the following floatation costs to Ramsey: $1.80 per share for preferred stock and $3 per share for common stock.
On the advise of my investment banker, I have kept the debt at 50% of assets and equity at 50%. I see no need sell either common or preferred stock in the foreseeable future as the business has generated enough internal funds for its investment needs when these funds are combined with debt financing. Ramsey's corporate tax rate is 35%.
Q1. Given the information above please calculate the cost of capital for the following:
a. Bond (debt) (Kd)
b. Preferred stock (Kp)
c. Common equity in the form of retained earnings (Ke)
Q2. What is Ramsey's cost of capital for common stock?
Q3. What is the weighted average cost of capital?