Question

Calculate component cost of capital and WACC for major expansion program assuming that entire capital is raised from new bonds, preferred stock and retained earnings.

– Tax rate = 40%.

– 15-year, 12% coupon, semiannual payment noncallable bonds sell for $1,153. New bonds will be privately placed with no flotation cost.

– 10%, $100 par value, perpetual preferred stock sells for $111.10. New preferred stocks are issued at 5% flotation cost

– Common stock sells for $50. D0 = $4.19 and g = 5%. Flotation cost for new stock issued is 15%

Answer 1

Answer a.

Par Value = $1,000
Current Price = $1,153

Annual Coupon Rate = 12%
Semiannual Coupon Rate = 6%
Semiannual Coupon = 6% * $1,000
Semiannual Coupon = $60

Time to Maturity = 15 years
Semiannual Period = 30

Let Semiannual YTM be i%

$1,153 = $60 * PVIFA (i%, 30) + $1,000 * PVIF (i%, 30)

Using financial calculator:
N = 30
PV = -1153
PMT = 60
FV = 1000

I = 5.00%

Semiannual YTM = 5.00%
Annual YTM = 2 * 5.00%
Annual YTM = 10.00%

Cost of Debt = 10.00%

Answer b.

Par Value = $100

Annual Dividend = 10% * $100
Annual Dividend = $10

Flotation Cost = 5%

Cost of Preferred Stock = Annual Dividend / [Current Price * (1 - Flotation Cost)]
Cost of Preferred Stock = $10 / [$111.10 * (1 - 0.05)]
Cost of Preferred Stock = $10 / $105.545
Cost of Preferred Stock = 0.0947 or 9.47%

Answer c.

Last Dividend, D0 = $4.19
Growth Rate, g = 5%
Current Price, P0 = $50
Flotation Cost, F = 15%

D1 = $4.19 * 1.05
D1 = $4.3995

Cost of New Common Equity = D1 / [P0 * (1 - F)] + g
Cost of New Common Equity = $4.3995 / [$50 * (1 - 0.15)] + 0.05
Cost of New Common Equity = $4.3995 / $42.50 + 0.05
Cost of New Common Equity = 0.1535 or 15.35%