Question

the market price is $975 for the bonds, $ for the preferred stock, and $21 for common stock. flotation costs are 9% for bonds and 5% for preferred stock. the firm's tax rate is 46%. common stock will pay a $2.80 dividend which is not expected to grow.

a. calculate the weighted cost of the capital using only internal common equity.

b. Why do we need to determine the firm's overall weighted cost of capital and not just the individual component cost of capital?

Answer 1

Source of Financing	Market value	Weight
Bonds	7312501	13.22 %
Preferred Stock	6000002	10.85 %
Common Stock	42000003	75.93 %
	5531250	100 %
1750 bonds at $975 value each
210, 000 shares at $60 value each
3200, 000 shares at $21 value each

Cost of Debt

$ 975 * (1.09) or $887.50 = $70* (1 + Kd)^-15 + 1000 * (1+Kd)^-15

Using a financial calculator, kd equals 8.35%

kd=8.35% (1 - 0.46)

kd=4.51%

Cost of preferred stock

kps= $7.25 / $ 60* (1 - 0.05) = 12.72 %

Cost of Common Stock

kE= $2.80 / $ 21 = 13.33 %

weighted cost of the capital =

kd * weight of Debt + K_PS * weight of preferred stock + Ke * Weight of Common stock

= 4.51 * 0.1322 + 12.72 * 0.1085 + 13.33* 0.7593

= 12.10 %