Question: Howard Corp. (whose tax rate is 35%) needs to calculate the RRR for an average risk expansion project. The firm’s current capital structure consists of $5 million in debt, $2 million in preferred stock, and $7 million in common equity. The preferred stock has a dividend of $7.00 per share and a market price of $75. The debt has an interest rate of 7.5%, and the common stock’s beta is 1.55. The interest rate on 10-year U.S. Treasury bonds is 3.40%, and the market’s risk premium is 8.50%.

1. Calculate the cost of each of the firm’s financing components.
2. Calculate the firm’s weighted average cost of capital (Kw). Discuss the significance of Kw to Howard’s managers.
3. Draw the Security Market Line (SML) and show the position of Howard Corp.’s stock on that line. Also show the stock’s risk premium.
4. Assume that an investor forecasts a return of 15% on Howard’s common stock over the next year. Use the SML to explain whether the investor should add the stock to a diversified portfolio.

Price: $2.99

Solution: The downloadable solution consists of 2 pages
Deliverable: Word Document