Delta Chemical Corporation is expected to have the following capital structure for the foreseeable future:
Source of After-Tax FinancingPercent of Total FundsBefore-Tax CostCostDebt Short term Long term Equity Common stock30% 10 20 70% 5514% 1230%
The flotation costs are already included in each cost component. The marginal income tax rate (tx )for Delta is expected to remain at 40% in the future.
(a) Determine the cost of capital (k).
(b) If the risk-free rate is known to be 6% and the average return on S&P 500 is about 12%, determine the cost of equity with β = 1.2, based on the capital asset pricing principle.
(c) Determine the cost of capital on the basis of the cost of equity obtained in (b).