Wentworth Industries is 100 percent equity financed. Its current beta is 0.9. The expected market rate of return is 14 percent and the risk-free rate is 8 percent.

 

a.    Calculate Wentworth’s cost of equity.

b.  

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If Wentworth changes its capital structure to 30 percent debt, it estimates that

 

 

its beta will increase to 1.1. The after-tax cost of debt will be 7 percent. Should Wentworth make the capital structure  change?

 

INTERMEDIATE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INTERMEDIATE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CHALLENGE

 

8.     The Ewing Distribution Company is planning a $100 million expansion of its chain of discount service stations to several neighboring states. This expansion will be financed, in part, with debt issued with a coupon interest rate of 15 percent. The bonds have a 10-year maturity and a $1,000 face value, and they will be sold to net Ewing $990 after issue costs. Ewing’s marginal tax rate is 40 percent.

Preferred stock will cost Ewing 14 percent after taxes. Ewing’s common stock pays a dividend of $2 per share. The current market price per share is $15, and new shares can be sold to net $14 per share. Ewing’s dividends are expected to increase at an annual rate of 5 percent for the foreseeable future. Ewing expects to have $20 million of retained earnings available to finance the  expansion.

Ewing’s target capital structure is as    follows:

 

Debt	20%
Preferred stock	5
Common equity	75

Calculate the weighted cost of capital that is appropriate to use in evaluating this expansion program