Question

The firm's preferred stock pays an annual dividend of $5.40, and the stock sells for $60. Flotation costs of preferred stock was 10% of the stock value.

The firm's stock is selling for $80. The dividend paid in 2019 was $2.00, in 2018 was 1.87, in 2017 was 1.75 and .1.63 in 2016.  If the firm issue new stocks a 8% of the selling price will be charged as selling costs.

Bond’s yield to maturity is 12% The firm marginal tax rate is 30%

Calculate the actual Weighted Average Cost of Capital if the optimal capital structure is 55% debt, 15% Preferred Stocks and 30% Common equity

Answer 1

We have to calculate WACC.

We will first calculate the cost of equity, debt and preferred equity.

Cost of preferred stock = annual dividend / net proceeds per share

Annual dividend = $5.40

net proceeds per share = price of share - flotation cost

= $60 - ($60 * 10%) = $54

cost of preferred stock = $5.40 / $54 = 10%

cost of equity = (D1 / net proceeds per share) + growth rate.

Dividend in 2019 = dividend in 2016 * (1 + g)⁴

2 = $1.63 * (1 + g)⁴

g = ($2 / $1.63)^1/4 - 1 = 5.2472% or 5.25(approx)

next year dividend = last dividend * (1 + growth rate)

= 2 * (1 + 5.2472%) = $2.1049

net proceeds per share = price of share - flotation cost

net proceeds per share = $80 - ($80 * 8%) = $73.60.

cost of equity = (2.1049 / 73.60) + 5.2472% = 8.11%

cost of debt = Ytm * (1 - tax rate) = 12% * (1 - 30%) = 8.4%

WACC = (weight of common stock * cost of common stock) + (weight of debt * cost of debt) + (weight of preferred stock * cost of preferred stock)

WACC = (30% * 8.11%) + (55% * 8.4%) + (15% * 10%)

WACC = 9%

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