Exercise 4

Suppose that the market value of a company's common stock is estimated at $42 million. The

market value of its interest-bearing debt is estimated at $28 million, and the average before-tax

yield on the debt is 10 percent per year, which is equivalent on an after-tax basis to 6 percent per

year (equal to 10 percent times 0.60, assuming a 40-percent tax rate).

Assume that the company just described is currently paying a dividend of $8 per year and that

the stock is selling at a price of $100. The rate of growth of the dividend is projected to be 12

percent per year.

Estimate of the cost of the common stock equity and the Weighted average cost of capital.