During the last few years, Harry Davis industry has been too constructed by the high cost
of capital to make many capital investment. Recently though, capital cost have been
Declining, and the company has decided to look seriously at a major expansion program
Proposed by the marketing department. Assumed that you are an assistant to Leigh J.,
The financial VP. Your first task is to estimate Harry Davis cost of capital. Jones
Has provided you with the following data, which she believes may be relevant to your task.
A. The firms tax rate is 40%
B. The current price of Harry Davis 12% coupon, semiannual payment, noncallable
Bonds with 15yrs reminding to maturity is $1,153. Harry Davis does not use
Short term interest bearing debt on permanent basis. New bonds would be
Privately placed with no floatation cost.
C. The current price of the firms 10%, $100 par value, quarterly dividend, perpetual
Preferred stock is $116. Harry Davis would incur floatation cost equal to 5% of
The proceeds on a new issue.
D. Harrys common stock is currently selling at $50 per share. Its last divided
(D o) was $3.12, and dividends are expected to grow constant rate of 5.8% in
The foreseeable future. Harry Davis beta is 1.2, the yield on T-bonds is 5.6% and
The market risk premium is estimated to be 6%. For the own-bond-yield-plus-
Judgemental-risk-primium approach, the firm uses 3.2% risk premium.
E. Harry Davis target capital structure is 30% long term debt, 10% preferred stock,
And 60% common equity.
