Pacific Intermountain Utilities Company has a present capital structure (which t

Question

Pacific Intermountain Utilities Company has a present capital structure (which the company feels is optimal) of 50 percent long-term debt, 10 percent preferred stock, and 40 percent common equity. For the coming year, the company has determined that its optimal capital budget can be externally financed with $70 million of 10 percent first-mortgage bonds sold at par and $14 million of preferred stock costing the company 11 percent. The remainder of the capital budget will be financed with retained earnings. The company

Explanation / Answer

Pacific Intermountain Utilities Company: Retained earnings = Net income - dividends = $106 MM - 25 MM($2) = $56 million ki = 10%(1 - 0.4) = 6.0% kp = 11% (given) ke = $2/25 + 0.05 = 0.13 or 13% ka = 0.40(13%) + 0.10(11%) + 0.50(6%) = 9.3%

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