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17. Given an optimal capital structure that is 40% debt, calculate the weighted average cost of...

17. Given an optimal capital structure that is 40% debt, calculate the weighted average cost of capital given the following additional information: Assume that the company has no outstanding preferred stock. (10 points)  Bond coupon rate 10%  Current market price of the bond $1000  Expected dividend on common stock $4  Common stock price $80  Constant growth rate for common stock 9%  The firm expects to pay total flotation costs of $50,000 when it issues 10,000 shares.  Tax rate 35%

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Answer #1

The market price of the bond = Par value. Thus, the coupon rate = cost of debt = 10%

After tax cost of debt = Before tax cost of debt * (1 - rax rate)
= 10% * (1 - 0.35)
= 6.5%

Flotation cost per share = $50,000 / 10,000 = $5

Cost of equity = D1 / (P0 - f) + g
= $4 / ($80 - $5) + 9%
= ($4 / $75) + 0.09
= 0.0533 + 0.09
= 14.33%

Weight of debt = 40% or 0.40
Weight of equity = 1 - 40% = 60% or 0.60

Weighted average cost of capital (WACC) = (cost of debt * weight of debt) + (cost of equity * weight of equity)
= (6.5% * 0.40) + (14.33% * 0.60)
= 2.60% + 8.60%
= 11.20%

Weighted average cost of capital (WACC) = 11.20%

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