Your firm recently paid a dividend of $4 to common stockholders. Dividends are expected to grow at 8% per year for the foreseeable future.

Your firm recently paid a dividend of $4 to common stockholders. Dividends are expected to grow at 8% per year for the foreseeable future. The current stock price is $54. New shares could be sold for the same price, but flotation costs would amount to $6 per share.

Also, the firm can issue 20-year, $1,000 par bonds at a pre-tax cost of 11.4%. The firm's tax rate is 34%.

What is the firm's cost of capital if their capital structure consists of 60% external equity and 40% bonds?

Solutions

Expert Solution

Here,

Weight of External Equity = 60%

Weight of Bonds = 40%

Pre-Tax Cost of Bonds = 11.4%

Tax rate = 34%

Dividend Recently Paid = $4

Growth rate = 8%

Current Stock Price = $54

Floatation Costs = $6

Using the Formula of the Gordon Growth Model

Using the Formula of Weighted Average Cost of Capital

The firm's cost of capital is 13.21%.

Umair answered 1 year ago

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