Question
In: Finance
It is your job to determine your company’s marginal cost of capital schedule. The firm’s current...
It is your job to determine your company’s marginal cost of capital schedule. The firm’s current capital structure, which it considers optimal, consists of 30% debt, 20% preferred stock, and 50% common equity. The firm has determined that it can borrow up to $15 million in debt at a pre-tax cost of 7%, an additional $9 million at a pre-tax cost of 9%, and any additional debt funds at 11%. The firm expects to retain $25 million of its earnings; any additional income can be raised by issuing new common stock. The firm’s common stock currently trades at $30 per share, and it pays a $3.00 per share dividend. Dividends are expected to grow at a 5% annual rate over time. If the firm issues new common stock it will be sold to the public at a 10% discount. There will also be a $2.00 per share flotation cost. Preferred stock can be issued in unlimited quantities at a pre-tax cost of 12%. If the firm decides to raise more than $80m in capital, what is the cost of that capital? Assume a tax rate of 40%.
Solutions
Expert Solution
| Weighted average cost of debt | |||
| Amt. | Wt. to total | After-tax cost | Wt.*Cost |
| 15 | 18.75% | 4.20% | 0.79% |
| 9 | 11.25% | 5.40% | 0.61% |
| 80-24=56 | 70.00% | 6.60% | 4.62% |
| 80 | 100.00% | 6.02% | |
| Cost of retained earnings |
| ke=(Next dividend/Market price)+growth rate of dividends |
| ((3*1.05)/30)+5%= |
| 15.50% |
| Cost of new equity |
| ke=(Next dividend/Net proceeds of new issue)+growth rate of dividends |
| ((3*1.05)/((30*(1-10%)-2))+5%= |
| 17.60% |
| Cost of Preferred stock= |
| 12% |
| Given that |
| it considers optimal, consists of 30% debt, 20% preferred stock, and 50% common equity |
| and also that |
| the firm expects to retain $25 million of its earnings |
| balance 80-25= $ 55 millions need to be raised from outside |
| in the ratio of 30%,20% & 50% respectively of |
| debt,preferred stock & new common equity |
| Now, with the weights & the 3 respective costs known , |
| the weighted average cost of outside capital,ie. WACC |
| The WACC=(Wt.d*kd)=(Wt.ps*kps)+(Wt.e*ke) |
| ie.(30%*6.02%)+(20%*12%)+(50%*17.60%)= |
| 13.01% |
| the company’s marginal cost of capital,including the cost of retained earnings= |
| ((55/80*13.01%)+(25/80*15.5%)= |
| 13.79% |
| (ANSWER) |
jeff jeffy answered 8 months agoRelated Solutions
It is your job to determine your company’s marginal cost of capital schedule. The firm’s current...
It is your job to determine your company’s marginal cost of
capital schedule. The firm’s current capital structure, which it
considers optimal, consists of 30% debt, 20% preferred stock, and
50% common equity. The firm has determined that it can borrow up to
$15 million in debt at a pre-tax cost of 7%, an additional $9
million at a pre-tax cost of 9%, and any additional debt funds at
11%. The firm expects to retain $25 million of its earnings;...
The McGee Corporation finds it is necessary to determine its marginal cost of capital. McGee’s current...
The McGee Corporation finds it is necessary to determine its
marginal cost of capital. McGee’s current capital structure calls
for 50 percent debt, 25 percent preferred stock, and 25 percent
common equity. Initially, common equity will be in the form of
retained earnings (Ke) and then new common
stock (Kn). The costs of the various sources of
financing are as follows: debt, 7.2 percent; preferred stock, 10.0
percent; retained earnings, 12.0 percent; and new common stock,
13.2 percent.
a. What...
The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan’s current...
The Nolan Corporation finds it is necessary to determine its
marginal cost of capital. Nolan’s current capital structure calls
for 30 percent debt, 20 percent preferred stock, and 50 percent
common equity. Initially, common equity will be in the form of
retained earnings (Ke) and then new common
stock (Kn). The costs of the various sources of
financing are as follows: debt, 9.2 percent; preferred stock, 8
percent; retained earnings, 9 percent; and new common stock, 10.2
percent.
a. What...
The McGee Corporation finds it is necessary to determine its marginal cost of capital. McGee’s current...
The McGee Corporation finds it is necessary to determine its
marginal cost of capital. McGee’s current capital structure calls
for 50 percent debt, 20 percent preferred stock, and 30 percent
common equity. Initially, common equity will be in the form of
retained earnings (Ke) and then new common stock (Kn). The costs of
the various sources of financing are as follows: debt, 6.0 percent;
preferred stock, 8.0 percent; retained earnings, 9.0 percent; and
new common stock, 10.2 percent. a. What...
The McGee Corporation finds it is necessary to determine its marginal cost of capital. McGee’s current...
The McGee Corporation finds it is necessary to determine its
marginal cost of capital. McGee’s current capital structure calls
for 50 percent debt, 20 percent preferred stock, and 30 percent
common equity. Initially, common equity will be in the form of
retained earnings (Ke) and then new common
stock (Kn). The costs of the various sources of
financing are as follows: debt, 6.5 percent; preferred stock, 12.0
percent; retained earnings, 10.0 percent; and new common stock,
11.4 percent.
a. What...
The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan’s current...
The Nolan Corporation finds it is necessary to determine its
marginal cost of capital. Nolan’s current capital structure calls
for 30 percent debt, 30 percent preferred stock, and 40 percent
common equity. Initially, common equity will be in the form of
retained earnings (Ke) and then new common
stock (Kn). The costs of the various sources of
financing are as follows: debt (after-tax), 8.5 percent; preferred
stock, 6 percent; retained earnings, 12 percent; and new common
stock, 13.2 percent.
a....
The McGee Corporation finds it is necessary to determine its marginal cost of capital. McGee’s current...
The McGee Corporation finds it is necessary to determine its
marginal cost of capital. McGee’s current capital structure calls
for 35 percent debt, 20 percent preferred stock, and 45 percent
common equity. Initially, common equity will be in the form of
retained earnings (Ke) and then new common
stock (Kn). The costs of the various sources of
financing are as follows: debt, 9.5 percent; preferred stock, 7.0
percent; retained earnings, 15.0 percent; and new common stock,
12.2 percent.
a. What...
The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan’s current...
The Nolan Corporation finds it is necessary to determine its
marginal cost of capital. Nolan’s current capital structure calls
for 35 percent debt, 25 percent preferred stock, and 40 percent
common equity. Initially, common equity will be in the form of
retained earnings (Ke) and then new common
stock (Kn). The costs of the various sources of
financing are as follows: debt (after-tax), 5.4 percent; preferred
stock, 9 percent; retained earnings, 10 percent; and new common
stock, 11.2 percent.
a....
The McGee Corporation finds it is necessary to determine its marginal cost of capital. McGee’s current...
The McGee Corporation finds it is necessary to determine its
marginal cost of capital. McGee’s current capital structure calls
for 40 percent debt, 5 percent preferred stock, and 55 percent
common equity. Initially, common equity will be in the form of
retained earnings (Ke) and then new common
stock (Kn). The costs of the various sources of
financing are as follows: debt (after-tax), 6.0 percent; preferred
stock, 8.0 percent; retained earnings, 10.0 percent; and new common
stock, 10.2 percent.
a....
The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan’s current...
The Nolan Corporation finds it is necessary to determine its
marginal cost of capital. Nolan’s current capital structure calls
for 30 percent debt, 15 percent preferred stock, and 55 percent
common equity. Initially, common equity will be in the form of
retained earnings (Ke) and then new common
stock (Kn). The costs of the various sources of
financing are as follows: debt (after-tax), 4.6 percent; preferred
stock, 10 percent; retained earnings, 9 percent; and new common
stock, 10.2 percent.
a....
ADVERTISEMENT
ADVERTISEMENT
Latest Questions
- What are the options that might be considered in relation to introducing flexible work practices? What...
- Question 2 : Aggregate Scores: Write a program that opens 2 files, quiz.txt, and hw.txt. The...
- Define the term symbiosis specifically as it applies in a biological context. Compare and contrast parasitism,...
- A research team conducted a study showing that approximately 20% of all businessmen who wear ties...
- Research the internet for companies that have executed data science projects. Pick one company and describe...
- Explain two theories or frameworks for understanding how Western Europe emerged out of 1,000 years of...
- Two cannons are mounted as shown in the drawing and rigged to fire simultaneously. They are...
ADVERTISEMENT