Alpha Products maintains a capital structure of 40 percent debt and 60 percent c

Question

Alpha Products maintains a capital structure of 40 percent debt and 60 percent common equity. To finance its capital budget for next year, the firm will sell $50 million of 11 percent debentures at par and finance the balance of its $125 million capital budget with retained earnings. Next year Alpha expects net income to grow 7 percent to $140 million, and dividends also are expected to increase 7 percent to $1.40 per share and to continue growing at that rate for the foreseeable future. The current market value of Alpha's stock is $30. If the firm has a marginal tax rate of 40 percent, what is its weighted cost of capital for the coming year? Please show formulas and calculations.

Explanation / Answer

cost of equity is 1.4 / 30 + 0.07 = 11.67%

wieghted average Cost of capital = 11.67 * 0.6 + 11 * 0.4 * ( 1 - 0.4 ) = 9.64%

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