Question

Calculation of individual costs and WACC   Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The firm is in the 2424​% tax bracket.

Debt  The firm can raise debt by selling ​$1 comma 0001,000​-par-value, 66​% coupon interest​ rate, 1515​-year bonds on which annual interest payments will be made. To sell the​ issue, an average discount of ​$5050 per bond would have to be given. The firm also must pay flotation costs of ​$2525 per bond.

Preferred stock  The firm can sell 7.57.5​% preferred stock at its ​$100100​-per-share par value. The cost of issuing and selling the preferred stock is expected to be ​$55 per share. Preferred stock can be sold under these terms.

Common stock  The​ firm's common stock is currently selling for ​$6060 per share. The firm expects to pay cash dividends of ​$6.56.5 per share next year. The​ firm's dividends have been growing at an annual rate of 99​%, and this growth is expected to continue into the future. The stock must be underpriced by ​$88 per​ share, and flotation costs are expected to amount to $ 3$3 per share. The firm can sell new common stock under these terms.

Retained earnings  When measuring this​ cost, the firm does not concern itself with the tax bracket or brokerage fees of owners. It expects to have available

​$110 comma 000110,000

of retained earnings in the coming​ year; once these retained earnings are​ exhausted, the firm will use new common stock as the form of common stock equity financing.

a.  Calculate the​ after-tax cost of debt.

b.  Calculate the cost of preferred stock.

c.  Calculate the cost of common stock.

Answer 1

a). After-tax cost of debt:

FV = 1,000; PMT = coupon rate*1,000 = 60; N = 15; PV (or net proceeds) = 1,000 - 50-25 = 925, solve for RATE.

YTM = 6.81%

After-tax cost of debt = YTM*(1-Tax rate) = 6.81%*(1-24%) = 5.18%

b). Cost of preferred stock = annual dividend/current price = (7.5%*100)/55 = 13.64%

c). Current price P0 = 60; Underpricing (u) = 8; Flotation cost (f) = 3; Dividend (D1) = 6.5; annual growth rate (g) = 9%

Cost of new common stock = (D1/(P0-u-f)) + g

= (6.5/(60-8-3)) + 9% = 22.27%

Note: Please reconfirm that the annual growth rate is 9% as it is not clear in the question due to double typing.