Question

The XYZ Company has the following capital structure that it considers optimal:

DEBT 30%

PREFERRED STOCK 10%

COMMON STOCK 60%

The firm plans to spend $100,000,000 on new capital projects. New bonds can be sold at par with an 8% coupon rate. Preferred stock can be sold with a dividend of $2.75, a par value of $25.00, and a floatation cost of $2.00 per share. Common stock is presently selling at $35.00 per share. The last dividend paid was $3.00 and the firm expects to grow at a rate of 4% in the foreseeable future. The firm's marginal tax rate is 40%. Calculate the firm’s weighted average cost of capital.

Answer 1

Cost of Debt = Coupon Rate at Par*(1-Tax Rate) = 0.08*(1-0.4) = 0.048

Cost of Preferred Stock = Dividend/(Par Value-Floatation Cost) = 2.75/(25-2) = 2.73/23 = 0.119565

Cost of Common Stock = [{Last Dividend*(1+Growth Rate)}/Current Price]+Growth Rate = [{3*(1+0.04)}/35]+0.04 = 0.089143+0.04 = 0.129143

Source	Proportion	Cost	Proportion*Cost
Long Term Debt	0.3	0.048	0.0144
Preference Stock	0.1	0.119565	0.0119565
Common Stock Equity	0.6	0.129143	0.0774858
		WACC = [Sum of Proportion*Cost]	0.1038423 = 10.38423%