Question

Abbott Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The firm’s tax rate is 40%. The weighted average cost is measured by using the following weights:

Source of Capital	Weight
Long-term debt	40%
Preferred stock	10%
Common stock equity	50%
Total	100%

Debt

The firm can sell for $980 a 10-year, $1000-par-value bond paying annual interest at a 10% coupon rate. A flotation cost of 3% of the par value is required in addition to the discount of $20 per bond.

Preferred Stock

Eight percent (annual dividend) preferred stock having a par value of $100 can be sold for $65. An additional fee of $2 per share must be paid to the underwriters.

Common Stock

The firm’s common stock is currently selling for $50 per share. The dividend expected to be paid at the end of the coming year (2017) is $4. Its dividend payments, which have been approximately 60% of earnings per share in each of the past 5 years, were as follows:

Year	Dividend
2016	$3.75
2015	3.50
2014	3.30
2013	3.15
2012	2.85

It is expected that to attract buyers, new common stock must be underpriced $5 per share, and the firm must also pay $3 per share n flotation costs. Dividend payments are expected to continue at 60% of earnings.

Calculate the after-tax cost of debt.

Calculate the cost of preferred stock.

Calculate the cost of common stock.

Calculate the WACC for Abbott Labs.

Answer 1

	After-tax cost of debt.
	Amount recived per bond	$980
	Less:Floatation cost per bond(3% of face value)	$30	(0.03*1000)
	Net amount received	$950
	Coupon payment (10% of $1000)	$100
	Cost of Debt (Before tax shield)	0.105263158	(100/950)
	Cost of Debt (After tax shield)	0.063157895	0.105263158*(1-tax rate)
	After tax Cost of debt in percentage	6.32%
	cost of preferred stock
	Amount recived per share	$65
	Less:Underwriters fees	$2
	Net amount received	$63
	Annual dividend payment (8% of $100)	$8
	Cost of preferred share	0.126984127	(8/63)
	Cost of preferred share in percentage	12.70%
	cost of common stock.
	Current price=$50
	Dividend next year=$4
	Dividend growth rate:g
	4=2.85*((1+g)^5)		(2017-2012=5)
	1+g=(4/2.85)^(1/5)=	1.070145985
	Dividend growth rate	0.070145985
	Required rate of return=R
	50=4/(R-g)
	R=(4/50)+g
	R=(4/50)+0.070145985	0.150145985
	Required rate of return in percentage	15.01%
	Amount received per share=(50-5-3)	$42
	Return required =0.1501*50	7.50729925
	Cost of Equity =7.51/42	0.178809524
	Cost of equity in percentage	17.88%
	WACC for Abbott Labs.
		A	B	C=A*B
		Weight	Cost(%)	Weighted cost
	Debt	0.4	6.32	2.528
	preferred stock	0.1	12.7	1.27
	Common Stock	0.5	17.88	8.94
			TOTAL	12.738
	WACC	12.74%