Northman’s common equity, debt, and preferred equity are worth $70,000, $10,000 and $20,000 respectively with a total value is $100,000. The company’s common stock is currently listed at $54 per share; new preferred stock sells for $70 per share with a flotation cost of 10% and pays a dividend of $3.5 per share. Last year the company paid dividends of $2 per share on common stock, which is expected to grow at a constant rate of 5%. The local bank is willing to finance the project at 12% annual interest. Assuming the company’s tax rate is 35%, do the following computations:
1. What is the after-tax cost of debt?
2. What is the cost of common equity, assuming only retained earnings are used?
3. What is the cost of new preferred equity?
4. What is the Weighted Average Cost of Capital (WACC)?
5. In one paragraph, explain what WACC means. Why is it important to estimate WACC correctly?