Question

Calculation of individual costs and WACC  Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The firm is in the 27​% tax bracket.

Debt  The firm can raise debt by selling $1,000​-par-value, 5​% coupon interest​ rate, 15​-year bonds on which annual interest payments will be made. To sell the​issue, an average discount of​$35 per bond would have to be given. The firm also must pay flotation costs of ​$25 per bond.

Preferred stock  The firm can sell 7​% preferred stock at its $105​-per-share par value. The cost of issuing and selling the preferred stock is expected to be $6 per share. Preferred stock can be sold under these terms.

Common stock The​ firm's common stock is currently selling for $55 per share. The firm expects to pay cash dividends of ​$5.50 per share next year. The​ firm's dividends have been growing at an annual rate of 6​%, and this growth is expected to continue into the future. The stock must be underpriced by ​$6 per​ share, and flotation costs are expected to amount to $3 per share. The firm can sell new common stock under these terms.

Retained earnings When measuring this​ cost, the firm does not concern itself with the tax bracket or brokerage fees of owners. It expects to have available ​$100,000 of retained earnings in the coming​ year; once these retained earnings are​ exhausted, the firm will use new common stock as the form of common stock equity financing.

a.  Calculate the​ after-tax cost of debt.

b.  Calculate the cost of preferred stock.

c.  Calculate the cost of common stock.

d.  Calculate the​ firm's weighted average cost of capital using the capital structure weights shown in the following​ table

Source of capital	Weight
​Long-term debt	30%
Preferred stock	20
Common stock equity	50
Total	100%		​

Answer 1

WACC = Cost of Debt*Debt Weight + Cost of Preferred Stock*Weight of Preferred stock + Cost of common stock*Weightage of stock