Question

Calculate the weighted average cost of capital

Given:

• The firm has enough cash on hand to provide the necessary equity financing (no new common stock).
• Common Stock/Equity
  • 1,000,000 common shares outstanding
  • Current stock price is $11.25 per share
  • Dividends expected at $1.00 per share
  • Dividends will grow at 5% per year after that
  • Flotation costs for new share would be $0.10 per share
• Preferred Stock/Equity
  • 150,000 preferred share outstanding
  • Current preferred stock price is $9.50 per share
  • Dividend is $0.95 per share
  • If new share issued, they must be sold at 5% less than current market price and involve direct flotation costs of $0.25 per share
• Debt
  • $10,000,000 (par value) in outstanding debt in form of bonds
  • 10 years left to maturity.
  • Annual coupons at coupon rate of 11.3%
  • Currently price at 106% of par value ($10,600,000).
  • Flotation costs for new bonds would equal 6% of par value ($600,000)
• Tax rate
  • 40%

Answer 1

ANSWER:

Cost of Equity = (Dividend / (Stock Price - Floatation Cost)) + Growth Rate

Cost of Equity = (1 / (11.25 - 0.10)) + 5%

Cost of Equity = 13.97%

Cost of Preferred Stock = Dividend / (Price - Floatation Cost)

Cost of Preferred Stock = 0.95 / (9.025 - 0.25)

Cost of Preferred Stock = 0.95 / 8.775

Cost of Preferred Stock = 10.83%

Cost of Debt:

After Tax Cost of Debt = Cost of Debt * (1 - Tax)

After Tax Cost of Debt = 0.06 * (1 - 0.40)

= 0.06 * 0.6

After Tax Cost of Debt = 3.60%

WACC: