Consider a firm that is financed THREE ways: common equity, preferred equity, and long term debt. The firm is considering replacing all of the machinery in its Cleveland plant. They have more than enough cash on hand to pay for the project without raising external capital. Some relevant information about the firm is given below. Based on all three sources of funding, what cost of capital should the firm use to evaluate the project? (Assume that the Cleveland plant is representative of all the firms’ projects).
Stock Price (common shares) $12
Number of common shares outstanding 6M
Stock Price (preferred shares) $6
Number of preferred shares outstanding 10M
Market value of Total Debt outstanding 40M
Equity beta (for common stock) 2
Risk-free rate 4.5%
Historical return on the S&P 500 12.0%
Dividends per share on common stock $0.00
Dividends per share on preferred stock $1.00
Yield to maturity on the firm’s long term debt 6.5%
Coupon rate on the firms long term debt 3.0%
Corporate tax rate 35%