Question

In: Finance

Lumber Corp's common stock trades at a price of $40 per share. Last year's dividend was...

Lumber Corp's common stock trades at a price of $40 per share. Last year's dividend was $1.6 per share and is expected to grow by 5% per year. Flotation costs for common stock have been estimated at 6%.

The company's preferred stock is selling at $50 and has an annual dividend of $4.

Lumber Corp. has bonds outstanding with an average coupon rate of 12% and a yield to maturity of 9%.

The firm's optimum capital structure is 45% equity, 15% preferred stock and 40% debt, and its tax rate is 40%.

What is the (after-tax) cost of debt?

What is the cost of preferred stock?

What is the cost of retained earnings?

What is the cost of new common stock?

What is the WACC, assuming the company doesn't have to issue any new stock?

Expert Solution

What is the (after-tax) cost of debt?

After tax cost of debt = Yield to maturity x (1-tax rate)

After tax cost of debt = 9% x (1-40%)

After tax cost of debt = 5.40%

.

What is the cost of preferred stock?

Cost of preferred stock = Dividend / Current price

Cost of preferred stock = 4 / 50

Cost of the preferred stock = 8.00%

What is the cost of retained earnings?

Given details	#
Existing growth rate = g =	5.00%
Expected dividend = D0(1+g) = 1.6(1+5%)	1.68
Cost of retained earnings = r =	?

Current stock price = P0 =	40.00
Formula for calculating the Cost of retained earnings:
r = (D1/(P0))+g = 1.68/40 + 5%	9.20%

What is the cost of new common stock?

Given details	#
Existing growth rate = g =	5.00%
Expected dividend = D0*(1+g) =	1.68
Cost of new equity = r =	?
Flotation cost = f = 6% x 40 =	2.40
Current stock price = P0 =	40.00
Formula for calculating the Cost of new equity:
r = (D1/(P0-f))+g = 1.68/(40-2.4)+5%	9.468085%

What is the WACC, assuming the company doesn't have to issue any new stock?

WACC = Cost of retained earnings x Weight of equity + Cost of preferred share x Weight of preferred share + After tax cost of debt x Weight of debt

WACC = 9.20% x 45% + 8% x 15% + 5.40% x 40%

WACC = 7.50%

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