Question

In: Finance

Carter & Hill (C&H), a publicly traded company, is planning to raise new capital to fund...

Carter & Hill (C&H), a publicly traded company, is planning to raise new capital to fund an expansion into the Western part of the U.S. To maintain their current capital structure, they need to issue both debt and equity and have hired JP Capital, an investment banking firm, to handle the new issues. C&H figures that:

a. the cost of floating a new bond issue will cost about 2% of the proceeds and a new common stock will cost about 10% of the proceeds.

b. C&H expects to pay $3.00 next year in dividends and grow them at roughly 5% for the foreseeable future.

c. The firm’s tax rate is 40%.

d. C&H plans to issue 20 year bonds with a $1,000 par value and a 9% coupon rate.

e. JP Capital expects to offer C&H’s stock for $30 a share.

What will C&H’s cost of equity and cost of debt (after-tax) be as a result of these new issues? What is its cost of capital for the expansion if its target debt-equity ratio is 1.25?

Expert Solution

Par Value of Bond = $1,000

Floatation cost = 2%

Net Proceed from Bond Issue = $1,000 × (1 - 2%)

= $980

Net Proceed from sale of bond is $980.

Coupon Rate = 9%

Year maturity = 20 year

Before tax cost of debt that is YTM of bond is calculated in excel and screen shot provided below:

Before tax cost of debt is 9.22%.

Tax rate = 40%

after tax cost of debt = 9.22% × (1 - 40%)

= 5.53%

After Tax cost of debt is 5.53%.

Cost of equity

Current Share Price = $30

Floatation cost = 10%

Net Proceed from sale of equity = $30 × (1 - 10%)

= $27

Cost of equity = (Expected dividend / Net proceed) + Growth rate

= ($3 / $27) + 5%

= 11.11% + 5%

= 16.11%

Cost of equity is 16.11%.

Debt Equity ratio = 1.25

Weight of debt = 1.25 / ( 1 + 1.25)

= 55.56%

Weight of equity = 44.44%.

Now,

WACC is calculated below:

WACC = (55.56% × 5.53%) + (44.44% × 16.11%)

= 3.07% + 7.16%

= 10.23%

WACC that is cost of capital for company is 10.23%.

jeff jeffy answered 2 years ago

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