Question

Compute the weighted average cost of capital RIC Inc. using the following

information:

RIC Inc. has decided to finance this product line expansion by raising new capital. The company’s optimal capital structure calls for 35% debt, 40% equity, and 25% preferred stock. RIC Inc. can issue a series of 8% coupon bonds with a $ 1000 par value. The bonds will mature in 10 years and will sell for $ 946 minus an issuance cost of $ 5. RIC Inc.’s marginal tax rate is 35 %.

RIC Inc’s common stock is currently selling for $ 22 per share. Its present dividend is $ 1.96 a share and the expected long -term dividend growth rate is 8.5% . What is the cost of external equity for RIC Inc. assuming an issuance cost of $ 2.00 per share?

RIC Inc. has just issued shares of preferred stock that pay an annual dividend of $ 2.15. The preferred stock was sold to the public at a price of $ 52.00 per share with an issuance cost of $ 2.00 per share. What is the marginal cost of preferred stock for RIC Inc.?

Answer 1

To find the kD, we need to put the following values in the financial calculator:

INPUT	10		-(946-5)=-941	8%*1,000=80	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		8.92

So, After-tax kD = kD x (1 - t) = 8.92% x (1 - 0.35) = 5.80%

kE = [{D0 x (1 + g)} / {P0 - fc}] + g

= [($1.96 x 1.085) / ($22 - $2)] + 0.085 = 0.10633 + 0.085 = 0.19133, or 19.13%

kP = Annual Dividend / [Price - Issuance Cost] = $2.15 / [$52 - $2] = $2.15 / $50 = 4.30%

WACC = [wD x After-tax kD] + [wP x kP] + [wE x kE]

= [0.35 x 5.80%] + [0.25 x 4.30%] + [0.40 x 19.13%]

= 2.03% + 1.08% + 7.65% = 10.76%