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Lipscomb Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent...

Lipscomb Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for 1,000 USD. The firm could sell, at par, 100 USD preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Libscomb is a constant-growth firm which just paid a dividend of $2.00, sells for 27.00 USD per share, and has a growth rate of 8 percent. The firm's marginal tax rate is 40 percent.

Expert Solution

WACC is weighted avg cost of sources of finance in capital structure.

Cost of Debt = YTM

If the Bond is trading at par, COupon Rate and YTM will be same.

Thus YTM is 12%

After Tax cost of Debt = YTM ( 1 - Tax Rate )

= 12% ( 1 - 0.4)

= 12% * 0.6

= 7.2%

Prefence share cost = Preference div / Price ( 1 - Floatation COst )

= $ 12 / $ 100 ( 1 - 0.05)

= $ 12 / $ 100 *0.95

= $ 12 / $ 95

= 0.1263 I.e 12.63%

COmmon stock cost:

Particulars	Amount
D0	$ 2.00
Growth rate	8.0%
Price	$ 27.00

Ke = [ D1 / P0 ] + g
D1 = D0 ( 1 + g )
= 2 * ( 1 + 0.08 )
= 2 * ( 1.08 )
= 2.16

Ke = [ D1 / P0 ] + g
= [ 2.16 / 27 ] + 0.08
= 0.08 + 0.08
= 0.16
I.e 16 %

Where
D0 = Just Paid Div
D1 = Expected Div after 1 Year
P0 = Price Today
Ke = Required Ret
g = Growth Rate

WACC:

Source	Weight	Cost after Tax	Weighted Cost
Debt	0.2000	7.20%	1.44%
Preferred Stock	0.2000	12.63%	2.53%
Equity Stock	0.6000	16.00%	9.60%
WACC			13.57%

WACC is 13.57%

jeff jeffy answered 2 years ago

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