5. A firm has determined its optimal capital structure, which is composed of the following sources
and target market value proportions:
Sources of Capital Target Market Proportions
Long term debt 30%
Preferred stock 5
Common stock equity 65
Debt: The firm can sell a 20-year, $1,000 par value, 9 percent bond for $980. A flotation cost of 2
percent of the face value would be required in addition to the discount of $20.
Preferred Stock: The firm has determined it can issue preferred stock at $65 per share par value.
The stock will pay an $8.00 annual dividend. The cost of issuing and selling the stock is $3 per
Common Stock: The firm’s common stock is currently selling for $40 per share. The dividend
expected to be paid at the end of the coming year is $5.07. Its dividend payments have been
growing at a constant rate for the last five years. Five years ago, the dividend was $3.45. It is
expected that to sell, a new common stock issue must be underpriced at $1 per share and the firm
must pay $1 per share in flotation costs. Additionally, the firm’s marginal tax rate is 40 percent.
Calculate the firm’s weighted average cost of capital assuming the firm has exhausted all retained