In: Finance
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?
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%.
The firm's cost of capital is 13.21%.