As a member of the Finance Department of Ranch Manufacturing, your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the firm’s present capital structure reflects the appropriate mix of capital sources for the firm, you have determined the market value of the firm’s capital structure as follows:
Preferred stock: 2,500,000
Common stock: 6,500,000
To finance the purchase, ranch Manufacturing will sell 10-year bonds paying 6.6% per year at the market price of $1,061. Preferred stock paying a $2.04 dividend can be sold for $24.76. Common stock for Ranch Manufacturing is currently selling for $55.18 per share and the firm paid a $3.04 dividend last year. Dividends are expected to continue growing at a rate of 4.9% per year into the indefinite future. If the firm’s tax rate is 30%, what discount rate should you use to evaluate the equipment purchase?
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