The Capital Structure of Wildcat Wells, an Independent Petroleum Exploration

Essay

The capital structure of Wildcat Wells, an independent petroleum exploration and drilling company, consists of 40 percent debt and 60 percent equity capital. Debt capital consists of a bond (which matures in 10 years) issued five years ago at an interest rate of 10 percent. Since then market interest rates have risen substantially. The firm has been advised by its investment banker that additional debt financing (bonds) could be obtained at a rate of 12 percent. In the last six years of operations, Wildcat Wells has averaged a 12 percent compound rate of growth in earnings and dividends. This rate is expected to continue for the foreseeable future. Next year's dividend is projected to be $.75 per share. The firm's stock is currently selling for $25 per share. Wildcat Wells has a 40 percent marginal income tax rate.
(a)What is the firm's after-tax cost of debt financing?
(b)What is the firm's after-tax cost of internal equity capital?
(c)Assuming that Wildcat Wells plans to maintain its present capital structure, what is the firm's weighted cost of capital?