Question

Use the following information for the next five problems.

Zinger Corporation's optimum capital structure has been 35% debt, 10% preferred stock and 55% equity. The company always maintains this capital structure. Currently Zinger's common stock is traded at a price of $28 per share. Last year's dividend was $1.50 per share. The growth rate is 8%. Flotation costs have been estimated at 8% of common stockThe company's preferred stock is selling at $45 and has been yielding 6% in the current market. Flotation costs have been estimated at 3% of preferred stock. Zinger Corp. has bonds outstanding at 6%, but its investment banker has informed the company that interest rates for bonds of equal risk are currently yielding 5%. Zinger's tax rate is 40%.

11. Compute the cost of after tax cost of debt.

12.Compute the cost of preferred stock.

13.Compute the cost of new common equity.

14.Compute the cost of retained earnings.

15. Calculate the initial weighted average cost of capital using new common equity.

Answer 1

1.
Calculation of after tax cost of debt:

After taxx cost of debt = Before tax cost of debt * (1 - tax rate)
= 5% * (1 - 0.40)
= 3%

After taxx cost of debt = 3%

2.
Calculation of cost of preferred stock:

Cost of preferred stock = Annual dividend / (Current price * (1 - flotation cost))
= ($45 * 6%) / ($45 * (1 - 3%))
= $2.7 / $43.65
= 6.1856% or 6.19%

3.
Cost of new common stock = (D0 * (1+g)) / (P0 * (1 - flotation cost)) + g
= ($1.50 * (1+8%)) / ($28 * (1 - 8%)) + 8%
= $1.62 / $25.76 + 8%
= 6.2888% + 8%
= 14.2888% or 14.29%

4.
Cost of retained earnings = ((D0 * (1+g)) / P0) + g
= (($1.50 * (1+8%)) / $28) + 8%
= 13.7857% or 13.79%

5.
WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of common stock * cost of common stock)
= (35% * 3%) + (10% * 6.1856%) + (55% * 14.2888%)
= 9.53%

WACC = 9.53%