Question

Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 50 % long-term debt, 20 % preferred stock, and 30 % common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 20 %. Debt The firm can sell for $975 a 14 -year, $1 comma 000 -par-value bond paying annual interest at a 9.00 % coupon rate. A flotation cost of 3 % of the par value is required in addition to the discount of $25 per bond. Preferred stock 8.50 % (annual dividend) preferred stock having a par value of $100 can be sold for $70. An additional fee of $3 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $80 per share. The dividend expected to be paid at the end of the coming year (2016) is $2.94. Its dividend payments, which have been approximately 60 % of earnings per share in the past 5 years, were as shown in the following table:

It is expected that to attract buyers, new common stock must be underpriced $7 per share, and the firm must also pay $2.50 per share in flotation costs. Dividend payments are expected to continue at 60 % of earnings. (Assume thatr Subscript rrr = r Subscript srs .)

a. Calculate the after-tax cost of debt. ​(Round to two decimal​ places.)

b. Calculate the cost of preferred stock. ​(Round to two decimal​ places.)

c. Calculate the cost of common stock. ​(Round to two decimal​ places.)

d. Calculate the WACC for Dillon Labs. ​(Round to two decimal​ places.)

Click on the icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.)

Year		Dividend
2015		$2.792.79
2014		$2.642.64
2013		$2.502.50
2012		$2.372.37
2011		$2.252.25

Answer 1

a) Cost of debt can be calculated using I/Y function on a financial calculator

N = 14, PMT = 9% x 1000 = 90, PV = -(975 - 30) = -945, FV = 1000

=> Compute I/Y = 9.74% is the before-tax cost of debt

After tax cost of debt = 9.74% x (1 - 20%) = 7.79%

b) Cost of preferred debt = Dividend / (Price - Flotation) = 8.5 / (70 - 3) = 12.69%

c) Cost of common stock = D1 / (P - F) + g

where, D1 - next dividend, P - Price, F - Flotation, g - growth in dividends = (2.94 / 2.25)^(1/5) - 1 = 5.5%

r = 2.94 / (80 - 2.5 - 7) + 5.5% = 9.67%

d) WACC = wd x rd x (1 - tax) + wps x rps + we x re

= 50% x 7.79% + 20% x 12.69% + 30% x 9.67%

= 9.33%