Question

Given the following information: Percent of capital structure: Debt 35 % Preferred stock 20 Common equity 45 Additional information: Bond coupon rate 15% Bond yield to maturity 12% Dividend, expected common $ 2.00 Dividend, preferred $ 9.00 Price, common $ 45.00 Price, preferred $ 148.00 Flotation cost, preferred $ 6.20 Growth rate 6% Corporate tax rate 35% Calculate the Hamilton Corp.'s weighted cost of each source of capital and the weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

Answer 1

Given the following information,

debt	0.35
preferred stock	0.20
common stock	0.45

Additional information:

All percentages are converted into numbers by multiplying percentages with 100 in the below table,

Bond coupon rate	0.15
Bond yield to maturity	0.12
Dividend, expected common	$2.00
Dividend, preferred	$9.00
Price, common	$45.00
Price, preferred	$148.00
Flotation cost, preferred	$6.20
Growth rate	0.06
tax rate	0.35

Step 1:

Calculation of cost of debt, which is given by the formula,

Kd = bonds yied to maturity*(1-tax rate)

Kd = 0.12*(1-0.35)

Kd = 0.12*(0.65)

Kd = 0.078 or 7.8%

Step 2:

Calculation of cost of preferred stock, which is given by the formula,

Kp = Dp/ P - F.C

Where

Dp = Dividend, preferred = 9

P = Price, preferred = 148

F.C = Flotation cost, preferred = 6.20

Substituting these in the above, we get

Kp = 9/ (148 - 6.20)

Kp = 9/ 141.80

Kp = 0.06347 or 6.3470%

Step 3:

Calculation of cost of equity, which is given by the formula,

Ke = D1/P0 + g

Where

D1 = Dividend, expected common = 2

P0 = Price, common = 45

g = growth rate = 0.06

Substituting these we get,

Ke = 2/45 + 0.06

Ke = 0.04444 + 0.06

Ke = 0.104444 or 10.44%

Step 4:

Calculation of weighted cost of each source of capital, which is given by the formula,

Weighted cost = cost(after tax)*weight

cost after tax	weights	weighted cost	in percentage terms
0.0780	0.35	0.0273	2.73%
0.0635	0.20	0.0127	1.27%
0.1044	0.45	0.0470	4.70%

Step 5:

Calculation of weighted average cost of capital, which is given by

Sum of weighted costs of debt, preferred and equity

= 0.0273+0.0127+0.0470 = 0.0870 = 8.70%

cost after tax	weights	weighted cost
Kd = 0.0780	0.35	0.0273
Kp = 0.0635	0.20	0.0127
Ke = 0.1044	0.45	0.0470
		0.0870

Therefore,

Weighted cost of debt	2.73
Weighted cost of preferred	1.27
Weighted cost of equity	4.70

weighted average cost of capital is 8.70%