Litten Oil and Gas Company is a large company with common stock listed on the New York Stock Exchange and bonds traded over the counter.
The vice president of finance is planning to sell $75 million of bonds this year. Present market yields are 12.1%. Litten has $90 million of 7.5% non callable preferred stock outstanding and has no intentions of selling any preferred stock at any time in the future. The preferred stock is currently priced at $80 per share and its dividend per share is $7.80.
The company has had volatile earnings but its dividend per share had had 8% growth and this will continue. The expected dividend is $1.90 per share and common stock is selling for $40 per share. The company’s flotation costs are $2.50 per share preferred stock and $2.20 per share for common stock.
Litten keeps its debt at 50% of assets and its equity at 50%. Litten sees no need to sell common or preferred stock in the near future as is has generated enough internal funds for investment needs. The tax rate for the company is 40%
Calculated the following cost of capital:
a. bond
b. preferred stock
c. common stock in retained earnings
d. new common stock
e. weighted average cost of capital.
f. Which of the calculations ( a, b, c, d, e) should Litten use for evaluating projects? Fully explain why.