Question

P9-17 (similar to)

Calculation of individual costs and WACC   Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following​ weights:

35​%

​long-term debt,

10​%

preferred​ stock, and

55​%

common stock equity​ (retained earnings, new common​ stock, or​ both). The​ firm's tax rate is

24​%.

Debt The firm can sell for

​$1030

a

11​-year,

​$1,000​-par-value

bond paying annual interest at a

7.00​%

coupon rate. A flotation cost of

3​%

of the par value is required.Preferred stock  

9.50​%

​(annual dividend) preferred stock having a par value of

​$100

can be sold for

​$92.

An additional fee of

​$4

per share must be paid to the underwriters.Common stock  The​ firm's common stock is currently selling for

​$70

per share. The stock has paid a dividend that has gradually increased for many​ years, rising from

​$2.70

ten years ago to the

​$4.00

dividend​ payment,

Upper D 0D0​,

that the company just recently made. If the company wants to issue new new common​ stock, it will sell them

​$3.50

below the current market price to attract​ investors, and the company will pay

​$2.00

per share in flotation costs.  

a.  Calculate the​ after-tax cost of debt.

b.  Calculate the cost of preferred stock.

c.  Calculate the cost of common stock​ (both retained earnings and new common​ stock).

d.  Calculate the WACC for Dillon Labs.

a.  The​ after-tax cost of debt using the​ bond's yield to maturity​ (YTM) is

nothing​%.

​(Round to two decimal​ places.)

Answer 1

	a	After Tax Cost of debt
	Pv	Selling Price of bond	$1,030
	Nper	Number of years to maturity	11
	Pmt	Annual interest payment =1000*7%	$70
	Fv	Payment of par value at maturity	$1,000
	RATE	Yield to maturity	6.61%	(Using Rate function of excel with Nper=11, Pmt=70, Pv=-1030, Fv=1000)
		Flotation cost	3%
		Before tax cost of debt =6.61/(1-0.03)	6.81%
		Tax Rate	24%
		After Tax Cost of debt=6.81^(1-0.24)	5.18%
	b	Cost of Preferred stock
		Par Value	$100
		Annual dividend =9.5%*100	$9.50
		Selling Price	$92
		Additional Fee	$4
		Cost of Preferred stock=9.5/(92-4)	10.80%
	c	Cost of Retained Earnings
		Growth rate of dividend =g
		4=2.7*((1+g)^10)
		(1+g)^10=4/2.7=	1.481481
		1+g=1.481481^(1/10)=	1.040087
		g=Growth Rate	0.040087
		Growth rate of dividend =g	4.0%	0.04
		D1=Next years expected dividend=4*1.04	4.16
		Current Market Price =P0=	$70
		Required Return =R
		P0=D1/(R-g)=4.16/(R-0.04)
		70=4.16/(R-0.04)
		Required Return =R=(4.16/70)+0.04	0.099429
		Cost of Retained Earnings	9.94%
		Cost of new common stock
		Amount to be received per share=70-3.5-2	$64.50
		Cost of New Common stock=9.9*(70/64.5)	10.79%
	d	WACC considering New Common Stock:
		Weightof debt*Cost of debt+Weight of Preferred*Cost of Preferred+Weight of Common Stock*Cost of Common Stock
		35%*5.18%+10%*10.80%+55%*10.79%=	8.83%
		WACC=	8.83%