Question

McGee Corporation needs to calculate its marginal cost of capital. You are a financial analyst for...

McGee Corporation needs to calculate its marginal cost of capital. You are a financial analyst for the company and have gathered the following information:

                  Dividend, preferred stock……………………….......... …………..$6.00

                  Dividend, next expected, Common Stock……….......... ………..$1.10

                  Price, Preferred Stock (ignore any flotation cost)….......... ……$48.00

                  Price, Common Stock………………………………….......... …..$25.00

                  Flotation cost per share, common........................ 20% of stock price

                  Growth rate…………………………………………….......... ………10%

                  Bond yield........... …………………………………………………….11%

                  Bond face .......... ………………………………………………$1,000.00

                  Net income…………………………………………….... …….$25 million

                  Dividend payout rate…………………………………….......... ……30%

                  Corporate tax rate……………………………………........... ………40%

If McGee raises capital through debt, what is the company’s approximate after-tax cost of debt?

Here is the information for the McGee Corporation, which wants to calculate its marginal cost of capital.  

                  Dividend, preferred stock……………………….......... …………..$6.00

                  Dividend, next expected, Common Stock……….......... ………..$1.10

                  Price, Preferred Stock (ignore any flotation cost)….......... ……$48.00

                  Price, Common Stock………………………………….......... …..$25.00

                  Flotation cost per share, common........................ 20% of stock price

                  Growth rate…………………………………………….......... ………10%

                  Bond yield........... …………………………………………………….11%

                  Bond face .......... ………………………………………………$1,000.00

                  Net income…………………………………………….... …….$25 million

                  Dividend payout rate…………………………………….......... ……30%

                  Corporate tax rate……………………………………........... ………40%

If McGee raises capital through the sale of preferred stock, what is the company’s cost of preferred stock?

Here is the information for the McGee Corporation, which wants to calculate its marginal cost of capital.  

                  Dividend, preferred stock……………………….......... …………..$6.00

                  Dividend, next expected, Common Stock……….......... ………..$1.10

                  Price, Preferred Stock (ignore any flotation cost)….......... ……$48.00

                  Price, Common Stock………………………………….......... …..$25.00

                  Flotation cost per share, common........................ 20% of stock price

                  Growth rate…………………………………………….......... ………10%

                  Bond yield........... …………………………………………………….11%

                  Bond face .......... ………………………………………………$1,000.00

                  Net income…………………………………………….... …….$25 million

                  Dividend payout rate…………………………………….......... ……30%

                  Corporate tax rate……………………………………........... ………40%

If McGee raises capital by using its own retained earnings, what is the company’s cost of retained earnings?

Here is the information for the McGee Corporation, which wants to calculate its marginal cost of capital.   

                  Dividend, preferred stock……………………….......... …………..$6.00

                  Dividend, next expected, Common Stock……….......... ………..$1.10

                  Price, Preferred Stock (ignore any flotation cost)….......... ……$48.00

                  Price, Common Stock………………………………….......... …..$25.00

                  Flotation cost per share, common........................ 20% of stock price

                  Growth rate…………………………………………….......... ………10%

                  Bond yield........... …………………………………………………….11%

                  Bond face .......... ………………………………………………$1,000.00

                  Net income…………………………………………….... …….$25 million

                  Dividend payout rate…………………………………….......... ……30%

                  Corporate tax rate……………………………………........... ………40%

If McGee raises capital through the sale of common stock, what is the company’s cost of new common stock?

         Dallas Company has the following target capital structure:

                           Debt..................................... …..65%

                           Preferred Stock................... ……10%

                           Common Equity...................... …25%

         The following costs were calculated:

                           After tax cost of debt………...... ….8%

                           Cost of preferred stock…......... …12%

                           Cost of retained earnings…..... …15%

                           Cost of new common stock….. ….16%

What is the initial weighted average cost of capital, assuming all required funding is raised without issuing common stock?

         Dallas Company has the following target capital structure:

                           Debt..................................... …..65%

                           Preferred Stock................... ……10%

                           Common Equity...................... …25%

         The following costs were calculated:

                           After tax cost of debt………...... ….8%

                           Cost of preferred stock…......... …12%

                           Cost of retained earnings…..... …15%

                           Cost of new common stock….. ….16%

Assuming no beginning balance in retained earnings, and net income of $3,000,000, what is the maximum amount of financing the company could raise before they run out of retained earnings?

         Dallas Company has the following target capital structure:

                           Debt..................................... …..65%

                           Preferred Stock................... ……10%

                           Common Equity...................... …25%

         The following costs were calculated:

                           After tax cost of debt………...... ….8%

                           Cost of preferred stock…......... …12%

                           Cost of retained earnings…..... …15%

                           Cost of new common stock….. ….16%

What is the weighted average cost of capital if the company needs to raise more than the amount calculated in question 32 above, and therefore, equity financing cannot be obtained through the use of retained earnings?

Homework Answers

Answer #1

After Tax cost of Debt= kd*(1-t) = Bond yield * (1-t) = 11%* (1-0.4) = 6.6%

Cos tof Preferred stock = Preference Dividend per share/ Preference Share Price

= $6/$48 =12.5%

Cost of Retained Earnings = Next expected Dividend/common stock price + growth rate

=1.1/25+0.1

= 14.4%

Floatation cost per common stock =20% of share price =$5

Net realised amount per stock issued = $25-$5 = $20

So,Cost of Common stock = Next expected Dividend/common stock price + growth rate

= 1.1/20+0.1= 15.50%

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