Question

Given the following information, calculate the weighted average cost of capital for Puppet Corporation. (Round intermediate calculations to 2 decimal places. Round the final answers to 2 decimal places.)

Percent of capital structure:
Debt	40%
Preferred stock	40
Common equity	20
Additional information:
Bond coupon rate	8.5%
Bond yield	6.25%
Bond flotation cost	2%
Dividend, expected common	$1.50
Price, common	$30.00
Dividend, preferred	6%
Flotation cost, preferred	3%
Flotation cost, common	4.00%
Corporate growth rate	6%
Corporate tax rate	35%

a. Calculate the cost of capital assuming use of internally generated funds.

Internal capital cost             %

b. Calculate the cost of capital assuming use of externally generated funds.

External capital cost             %

c. Not suitable for Connect

Answer 1

(a)

Cost of Debt
YTM	6.25%
After tax cost of debt	6.25 x (1 - 0.35)	4.0625%
After tax cost of debt adjusted for floatation cost	4.0625 x (1 - 0.02)	3.98%
Cost of preferred stock
Yield	6%/ (1 - 0.03)	6.19%
Cost of common stock
Yield	(1.50/30) + 0.06	11%
Debt	40%	3.98%
Preferred stock	40%	6.19%
Common stock	20%	11%
WACC	(3.98 x 0.40) + (6.19 x 0.40) + (11 x 0.20)	6.27%

(b)

Cost of Debt
YTM	6.25%
After tax cost of debt	6.25 x (1 - 0.35)	4.0625%
After tax cost of debt adjusted for floatation cost	4.0625 x (1 - 0.02)	3.98%
Cost of preferred stock
Yield	6%/ (1 - 0.03)	6.19%
Cost of common stock
Yield [Cost of retained earnings/ (1 - Floatation cost)]	11%/ (1 - 0.04)	11.46%
Debt	40%	3.98%
Preferred stock	40%	6.19%
Common stock	20%	11.46%
WACC	(3.98 x 0.40) + (6.19 x 0.40) + (11.46 x 0.20)	6.36%