Question

A firm is considering a new project which would be similar in terms of risk to its existing projects. The firm needs a discount rate for evaluation purposes. The firm has enough cash on hand to provide the necessary equity financing for the project. Also, the firm: 1) has 1,000,000 common shares outstanding, current price $11.25 per share, next year's dividend expected to be $1 per share, firm estimates dividends will grow at 5% per year after that, flotation costs for new shares would be $0.10 per share 2) has 150,000 preferred shares outstanding, current price is $9.50 per share, dividend is $0.95 per share, if new preferred are issued, they must be sold at 5% less than the current market price (to ensure they sell) and involve direct flotation costs of $0.25 per share 3) has a total of $10,000,000 (par value) in debt outstanding. The debt is in the form of bonds with 10 years left to maturity. They pay annual coupons at a coupon rate of 11.3%. Currently, the bonds sell at 106% of par value. Flotation costs for new bonds would equal 6% of par value. The firm's tax rate is 40%. What is the appropriate discount rate for the new project?

Answer 1

1-	cost of equity	(expected dividend/net proceeds)+growth rate	(1/11.15)+5%	13.97%
	net proceeds	11.25-.10	11.15
2-	cost of preferred stock	(preferred dividend/net proceed)	(.95/9.025)	10.53%
	net proceeds	9.5*(1-.05)	9.025
3-	cost of debt	interest+(face value-market value)/ years to maturity / (face value+market value)/2	113+(1000-1000)/10 (1000+1000)/2	113/1000	11.30%
	after tax cost of debt	before tax cost of debt*(1-.4)	11.3*(1-.4)	6.78
	Net proceeds	1060-60	1000
	It is assumed that par value of bond is 1000
	source	Market Value of security	weight	cost	weight*cost
	debt	10600000	0.46	6.78	3.087777
	preferred stock	1425000	0.06	10.53	0.644694
	common stock	11250000	0.48	13.97	6.752417
		23275000	WACC	sum of weight*cost	10.48