Question

# The Imaginary Products Co. currently has debt with a market value of \$275 million outstanding. The...

The Imaginary Products Co. currently has debt with a market value of \$275 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at \$1,392.42 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of \$11. The preferred shares pay an annual dividend of \$1.20. Imaginary also has 14 million shares of common stock outstanding with a price of \$20.00 per share. The firm is expected to pay a \$2.20 common dividend one year from today, and that dividend is expected to increase by 6 percent per year forever. If Imaginary is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital?

Calculate the cost of debt.?

What is the firm’s weighted average cost of capital?

 Market values (in Millions) Formula Notes Debt 275 Preferred shares 22 2M*11 per share Equity shares 280 14M*20 per share Total capital 577 Cost of debt 5.40% 0.09*(1-0.4) Debt interest is tax deductable Cost of preference shares 10.91% 1.2 Dividend/11 market price Dividend is not tax deductable. To find the % cost, divide Dividend by market price Cost of equity shares 17% 2.2 Dividend/20 market price +0.06 growth Dividend/Market price + Growth WACC calculation Market values (in Millions) Cost of capital WACC Formula Debt 275 5.40% 2.57% 5.4%*275/577 Preferred shares 22 10.91% 0.42% 10.91%*22/577 Equity shares 280 17.00% 8.25% 17*280/577 Total 577 11.24%

1. Cost of debt = 5.4%

2. WACC = 11.24%

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