Question

A-Rod Manufacturing Company is trying to calculate its cost of
capital for use in making a capital budgeting decision. Mr. Jeter,
the vice-president of finance, has given you the following
information and has asked you to compute the weighted average cost
of capital.

The company currently has outstanding a bond with a 11.2 percent
coupon rate and another bond with an 8.8 percent rate. The firm has
been informed by its investment banker that bonds of equal risk and
credit rating are now selling to yield 12.1 percent. The common
stock has a price of $66 and an expected dividend
(*D*_{1}) of $1.86 per share. The historical growth
pattern (*g*) for dividends is as follows:

$ | 1.41 |

1.55 | |

1.70 | |

1.86 | |

The preferred stock is selling at $86 per share and pays a dividend
of $8.20 per share. The corporate tax rate is 30 percent. The
flotation cost is 2.5 percent of the selling price for preferred
stock. The optimum capital structure for the firm is 20 percent
debt, 10 percent preferred stock, and 70 percent common equity in
the form of retained earnings.

**a.** Compute the average historical growth rate.
**(Do not round intermediate calculations. Round your answer
to the nearest whole percent and use this value as g.
Input your answer as a whole percent.)**

**b.** Compute the cost of capital for the
individual components in the capital structure. **(Use the
rounded whole percent computed in part a for g. Do not
round any other intermediate calculations. Input your answers as a
percent rounded to 2 decimal places.)**

**c.** Calculate the weighted cost of each source
of capital and the weighted average cost of capital. **(Do
not round intermediate calculations. Input your answers as a
percent rounded to 2 decimal places.)**

Answer #1

**a]**

Dividend in year 4 = dividend in year 1 * (1 + growth rate)3

$1.86 = $1.41 * (1 + growth rate)3

growth rate = ($1.86 / $1.41)1/3 - 1

growth rate = 9.67%

This is rounded off to 10%

**b]**

cost of debt = yield on bonds * (1 - tax rate) = 12.1% * (1 - 30%) = 8.47%

cost of preferred stock = dividend per share / net proceeds per share

net proceeds per share = current price - flotation costs = $86 - ($86 * 2.5%) = $83.85

cost of preferred stock = $8.20 / $83.85 = 9.78%

cost of retained earnings = (expected dividend / current price per share) + growth rate

cost of retained earnings = ($1.86 / $66) + 10%

cost of retained earnings = 12.82%

**c]**

WACC = (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock) + (weight of retained earnings * cost of retained earnings)

WACC = (20% * 8.47%) + (10% * 9.78%) + (70% * 12.82%)

WACC = 11.64%

A-Rod Manufacturing
Company is trying to calculate its cost of capital for use in
making a capital budgeting decision. Mr. Jeter, the vice-president
of finance, has given you the following information and has asked
you to compute the weighted average cost of capital.
The company currently
has outstanding a bond with a 11.5 percent coupon rate and another
bond with an 9.1 percent rate. The firm has been informed by its
investment banker that bonds of equal risk and credit...

A-Rod Manufacturing Company is trying to calculate its cost of
capital for use in making a capital budgeting decision. Mr. Jeter,
the vice-president of finance, has given you the following
information and has asked you to compute the weighted average cost
of capital.
The company currently has outstanding a bond with a 9.6 percent
coupon rate and another bond with an 7.2 percent rate. The firm has
been informed by its investment banker that bonds of equal risk and
credit...

A-Rod Manufacturing Company is trying to calculate its cost of
capital for use in making a capital budgeting decision. Mr. Jeter,
the vice-president of finance, has given you the following
information and has asked you to compute the weighted average cost
of capital.
The company currently has outstanding a bond with a 11.0 percent
coupon rate and another bond with an 8.6 percent rate. The firm has
been informed by its investment banker that bonds of equal risk and
credit...

A-Rod Manufacturing Company is trying to calculate its cost of
capital for use in making a capital budgeting decision. Mr. Jeter,
the vice-president of finance, has given you the following
information and has asked you to compute the weighted average cost
of capital.
The company currently has outstanding a bond with a 10.9 percent
coupon rate and another bond with an 8.5 percent rate. The firm has
been informed by its investment banker that bonds of equal risk and
credit...

A-Rod Manufacturing Company is trying to calculate its cost of
capital for use in making a capital budgeting decision. Mr. Jeter,
the vice-president of finance, has given you the following
information and has asked you to compute the weighted average cost
of capital.The company currently has outstanding a bond with a 10.9
percent coupon rate and another bond with an 8.5 percent rate. The
firm has been informed by its investment banker that bonds of equal
risk and credit rating...

A-Rod Manufacturing Company is trying to calculate its cost of
capital for use in making a capital budgeting decision. Mr. Jeter,
the vice-president of finance, has given you the following
information and has asked you to compute the weighted average cost
of capital.
The company currently has outstanding a bond with a 11.0 percent
coupon rate and another bond with an 8.6 percent rate. The firm has
been informed by its investment banker that bonds of equal risk and
credit...

A-Rod Manufacturing Company is trying to calculate its cost of
capital for use in making a capital budgeting decision. Mr. Jeter,
the vice-president of finance, has given you the following
information and has asked you to compute the weighted average cost
of capital. The company currently has outstanding a bond with a
11.5 percent coupon rate and another bond with an 9.1 percent rate.
The firm has been informed by its investment banker that bonds of
equal risk and credit...

A-Rod Manufacturing Company is trying to calculate its cost of
capital for use in making a capital budgeting decision. Mr. Jeter,
the vice-president of finance, has given you the following
information and has asked you to compute the weighted average cost
of capital.
The company currently has outstanding a bond with a 9.6 percent
coupon rate and another bond with an 7.2 percent rate. The firm has
been informed by its investment banker that bonds of equal risk and
credit...

A-Rod Manufacturing Company is trying to calculate its cost of
capital for use in making a capital budgeting decision. Mr. Jeter,
the vice-president of finance, has given you the following
information and has asked you to compute the weighted average cost
of capital.
The company currently has outstanding a bond with a 10.4 percent
coupon rate and another bond with an 8.0 percent rate. The firm has
been informed by its investment banker that bonds of equal risk and
credit...

Problem 11-25 Changes in cost and weighted average cost of
capital [LO11-1] A-Rod Manufacturing Company is trying to calculate
its cost of capital for use in making a capital budgeting decision.
Mr. Jeter, the vice-president of finance, has given you the
following information and has asked you to compute the weighted
average cost of capital. The company currently has outstanding a
bond with a 10.1 percent coupon rate and another bond with an 7.7
percent rate. The firm has been...

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