Question

Given the following information, calculate the weighted average cost of capital for Puppet Corporation. (Round intermediate calculations to 2 decimal places. Round the final answers to 2 decimal places.) Percent of capital structure: Debt 45% Preferred stock 30 Common equity 25 Additional information: Bond coupon rate 8.5% Bond yield 7.50% Bond flotation cost 2% Dividend, expected common $1.50 Price, common $30.00 Dividend, preferred 7% Flotation cost, preferred 3% Flotation cost, common 4.00% Corporate growth rate 5% Corporate tax rate 35% a. Calculate the cost of capital assuming use of internally generated funds. Internal capital cost % b. Calculate the cost of capital assuming use of externally generated funds. External capital cost % c. Not suitable for Connect

Answer 1

a) Internal cost of capital = 6.91%

working note

Cost of debt = Bond yield (1- tax rate ) / (1 - floating cost)

= 7.50 * (1- 0.35) / (1- 0.02) = 4.98%

Cost of preferred capital = Preferred dividend / (1 - floating cost)

= 7 / (1- 0.03) = 7.22 %

Cost of equity = (Expexted dividend / Price of commom stock) + Corporate growth

= (1.5 / 30) + 0.05 = 10%

Internal cost of capital = (Cost of debt * 45%) + (Cost of preferred capital * 30 %) + (Cost of equity * 25 %)

= (4.98 * 45%) + ( 7.22 * 30%) + (10 * 25%)

= 2.24 % + 2.17 % + 2.50 % = 6.91%.

b) External cost of capital = 7.02 %

working note

Cost of debt = 4.98%

Cost of preferred capital = 7.22 %

Cost of equity = Cost of equity / (1 - floating cost) = 10 / (1 - 0.04) = 10.42%

External cost of capital = (Cost of debt * 45%) + (Cost of preferred capital * 30 %) + (Cost of equity * 25 %)

= (4.98 * 45%) + ( 7.22 * 30%) + (10.42 * 25%)

= 2.24 % + 2.17 % + 2.61 %= 7.02 %