The Kenny Company has 10,000 bonds outstanding. The bonds are selling at 98% of face value,...

The Kenny Company has 10,000 bonds outstanding. The bonds are selling at 98% of face value, have a 10% coupon rate, pay interest semi-annually, and mature in 9 years. There are 1.87 million shares of common stock outstanding with a market price of $15 a share and a beta of 0.89. The common stock just paid a dividend of $0.7474 and expects to increase those dividends by 1.35% annually. The flotation cost for equity is 6.5% and the flotation cost for debt is 4.5%. The firm's marginal tax rate is 34%. The market risk premium is 5.5% and the Treasury bill rate is 1.5%. The company’s initial investment for a new project is $1,915,070.

What is the cost of equity based on the dividend growth model? (6.4%)
What is the after-tax cost of debt financing? (6.82%)
What is the company’s weighted average cost of capital? (6.51%)

What is the company’s initial investment after taking the flotation costs into account.

Expert Solution

cost of equity	(expected dividend/market price)+growth rate	(0.7574/15)+1.35%	6.40%
expected dividend	.7474*1.0135	0.7574899

cost of debt	Using rate function in MS excel	rate(nper,pmt,pv,fv,type)	5.17%
cost of debt annual	5.17*2	10.34
after tax cost of debt	10.34*(1-.34)	6.82

weighted average cost of capital
source	market value	weight	cost	weight*cost
debt	10000000	0.2628121	6.82	1.79353482
common stock	28050000	0.7371879	6.4	4.71800263
	38050000		WACC = sum of weight*cost	6.51153745

		Debt		common stock
Market value weight		26.28		73.72
value of Initial investment from debt and Equity = market value weight*after flotation cost fund)	1915070*26.28%	503280.4	1915070*73.72%	1411789.6
fund involved with flotation cost involved with the issue = after floation cost fund/(1-flotation cost)	503280.4/95.5%	526995.18	1411789.6/93.5%	1509935.41
total initial investment with floatation cost	526995.18+1509935.41	2036930.6

cost of debt- semiannual	Interest+(redemption value-market value/period to maturity) / (redemption value+market price)/2	500+(10000-9800)/18 / (10000+9800)/2	511.11/9900	5.16%
Annual cost of debt	5.16*2	10.32
after tax cost of debt	10.32*(1-.34%)	6.81

weighted average cost of capital
weight of debt	market value of debt/total value of capital	10000000/38050000	0.26281209
weight of common stock	market value of common stock/total value of capital	28050000/38050000	0.73718791
WACC	(weight of debtafter tax cost of debt)+(weight of common stockcost of common stock)	(.26286.81)+(.73716.40)	6.51

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