Question

You are working as a consultant to the Lulu Athletic Clothing​ Company, and you have been asked to compute the appropriate discount rate to use in the evaluation of the purchase of a new warehouse facility. You have determined the market value of the​ firm's current capital structure​ (which the firm considers to be its target mix of financing​ sources) as​ follows:

Source of Capital	Market Values
Bonds	​$250 comma 000250,000
Preferred stock	​$240 comma 000240,000
Common stock	​$520 comma 000

To finance the​ purchase, Lulu will sell 20​-year bonds with a ​$1,000 par value paying 5.6 percent per year​ (with interest paid​ semiannually) at the market price of $1,017. Preferred stock paying a $2.44 dividend can be sold for $35.45. Common stock for Lulu is currently selling for $49.55 per share. The firm paid a $3.99 dividend last year and expects dividends to continue growing at a rate of 3.5 percent per year for the indefinite future. The​ firm's maginal tax rate is 34 percent. What discount rate should you use to evaluate the warehouse​ project?

a. Calculate component weights of capital.

The weight of debt in the​ firm's capital structure is ___%.​(Round to two decimal​ places.)

The weight of preferred stock in the​ firm's capital structure is ___​%. ​(Round to two decimal​ places.)

The weight of common stock in the​ firm's capital structure is ___​%. ​(Round to two decimal​ places.)

b. Calculate component costs of capital.

The​ after-tax cost of debt for the firm is ___%. (Round to two decimal​ places.)

The cost of preferred stock for the firm is ___%. (Round to two decimal​ places.)

The cost of common equity for the firm is ___%. ​(Round to two decimal​ places.)

c. Calculate the​ firm's weighted average cost of capital.

The discount rate you should use to evaluate the warehouse project is ___%

Answer 1