problem: The Ewing Distribution Co. is planning a 100 million dollar 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 6.8 percent. The bonds have a ten year maturity with a $1,000 face value, and they will be sold to net Ewing 990 dollar per bond. Ewing's marginal tax rate is 40 percent.
Preferred stock will cost Ewing 7.5% after taxes. Ewing's common stock pays a dividend of $2 per share. The current market price per share is 35 dollar. Ewing's dividends are expected to increase at an annual rate of 5% for the foreseeable future. Ewing expects to create sufficient retained earnings to meet the common equity portion of the funding needed for the expansion.
Ewing's target capital structure is as follows:
Debt = 20%
Preferred Stock = 5%
Common Equity = 75%
Compute the weighted cost of capital that is appropriate to use in evaluating this expansion program.