Question

Problem 21-01

HBM, Inc has the following capital structure:

Assets	$	350,000		Debt	$	87,500
				Preferred stock		17,500
				Common stock		245,000

The common stock is currently selling for $13 a share, pays a cash dividend of $0.50 per share, and is growing annually at 4 percent. The preferred stock pays a $7 cash dividend and currently sells for $85 a share. The debt pays interest of 7.0 percent annually, and the firm is in the 30 percent marginal tax bracket.

1. What is the after-tax cost of debt? Round your answer to two decimal places.

     %

2. What is the cost of preferred stock? Round your answer to two decimal places.

     %

3. What is the cost of common stock? Assume that the current $0.50 dividend grows by 4 percent during the year. Round your answer to two decimal places.

     %

4. What is the firm’s weighted-average cost of capital? Round your answer to two decimal places.

     %

Answer 1

a. The after tax cost of debt is :

= The yield to matuirty * (1 - tax rate)

= 7% * 0.7

= 4.9%

b. The costs of preferred stock is :

= Dividend/ price of preference share

= $7/ $85

= 8.2353%

= 8.24% ( rounded off to two decimal places)

c. The cost of common equity is :

Re = D1/Po + g

= $0.5*1.04 / $13 + 0.04

= 8% ( rounded off to two decimal places)

d. The WACC is :

= weight of debt * after tax cost of debt + weight of preference share*cost of preference share + weight of equity*cost of equity

= $87,500/ $350,000*0.049 + $17,500/ $350,000*0.0824 + $245,000/ $350,000* 0.08

= 0.0123 + 0.0041 + 0.056

= 7.24% ( rounded off to two decimal places)

So, the WACC is 7.24%