Question

2. The Horizon Corp. has 60 million shares of common stock with a current market price of $24.00 per share. They have $400 million in par value of long-term bonds outstanding that currently sell for $1,075 per $1,000 par value. The bonds have a coupon rate of 8.5% and a maturity of 20 years. Assume semi-annual coupon payments. Horizon also has $220 million in par value of preferred stock with a current market price of $108 per $100 of par value. The dividend on this preferred stock is $8.50 per year.

The dividend on common stock in the most recent year (i.e. D0) was $1.30. The dividend growth rate is expected to be 4% per year for a long time.

Flotation costs on new preferred stock will be about 4%. On new common stock flotation costs would be about 8%. Flotation costs on new bonds would be negligible.

Assuming a combined state and federal marginal tax rate of 40%, estimate Horizon’s cost of capital. Assume that they use new common stock to finance expansions.

Answer 1

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