Question

You have collected the following data:

The outstanding debt instrument (bonds) yield is estimated at 7.75%; the applicable tax rate is 34%; the company is expected to have its next (expected) dividend is $0.65 a share; the dividend growth rate is expected to be at a constant rate of 6.00% a year.
The current stock price is $18.00 per share; the flotation cost for issuing debt is estimated at Fd = 5%; the flotation cost for selling new shares is estimated at Fcs = 10%;
The target capital structure is 40% debt and 60% common equity.

What is the firm's after-tax cost of prefer stock?

Answer 1

Calculation of cost of equity

= 0.65/18(1-0.1) + 0.06

= 0.65/16.20 + 0.06

=0.04012 + 0.06

=0.1002

= 10.02%

Calculation of cost of debt (bond)

Cost of Debt =( Interest Rate (1 – Tax Rate) )

= 0.0775 ( 1- 0.34) *

= 0.05115 ( 5.115%)

Calculation of WACC

	Weights	Cost of funds	Weights * cost of fuds
Equity	0.60	0.10012	0.0601
Debt	0.40	0.05115	0.0204
	WACC		0.0805

WACC of Firm is 0.0805 ( 8.05%)