Question

# Cost of capital    Edna Recording​ Studios, Inc., reported earnings available to common stock of \$4,000,000 last...

Cost of capital

Edna Recording​ Studios, Inc., reported earnings available to common stock of \$4,000,000 last year. From those​ earnings, the company paid a dividend of \$1.15 on each of its 1,000,000 common shares outstanding. The capital structure of the company includes 35​% debt, 15​% preferred​ stock, and 50​% common stock. It is taxed at a rate of 27​%.

a.  If the market price of the common stock is \$40 and dividends are expected to grow at a rate of 8​% per year for the foreseeable​ future, what is the​ company's cost of retained earnings financing​?

b.  If underpricing and flotation costs on new shares of common stock amount to ​\$8 per​ share, what is the​ company's cost of new common stock financing​?

c.  The company can issue \$2.39 dividend preferred stock for a market price of ​\$35 per share. Flotation costs would amount to \$4 per share. What is the cost of preferred stock financing​?

d.  The company can issue ​\$1,000​-par-value, 11​% ​coupon, 10​-year bonds that can be sold for \$1,270 each. Flotation costs would amount to ​\$40 per bond. Use the estimation formula to figure the approximate​ after-tax cost of debt​ financing?

e.  What is the WACC​?

If the market price of the common stock is ​\$40 and dividends are expected to grow at a rate of 8​% per year for the foreseeable​ future, the ​company's cost of retained earnings financing is ____​%. ​(Round to two decimal​ places.)

 a) Cost of retained earnings (using the constant dividend growth model) = 1.15*1.08/40+0.08 = 11.11% b) Cost of new common stock = 1.15*1.08/(40-8)+0.08 = 11.88% c) Cost of preferred stock = 2.39/(35-4) = 7.71% d) Before tax cost of debt = ((110+(1230-1000)/10))/((1230+1000)/2)) = 11.93% After tax cost of debt = 11.93%*(1-27%) = 8.71% e) WACC (with retained earnings) = 11.11%*50%+7.71%*15%+8.71%*35% = 9.76% WACC (with new common stock) = 11.88%*50%+7.71%*15%+8.71%*35% = 10.15%