In: Finance
Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 40% long-term debt, 20% preferred stock, and 40% common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 25%.
Debt The firm can sell for $980 a 13-year, $1,000-par-value bond paying annual interest at a 7.00% coupon rate. A flotation cost of 2% of the par value is required in addition to the discount of $20 per bond.
Preferred stock 8.00% (annual dividend) preferred stock having a par value of $100 can be sold for $85. An additional fee of $3 per share must be paid to the underwriters.
Common stock The firm's common stock is currently selling for $50 per share. The dividend expected to be paid at the end of the coming year (2016) is $3.16. Its dividend payments, which have been approximately 50% of earnings per share in the past 5 years, were as shown in the following table:
Year Dividend
2015 2.95
2014 2.76
2013 2.58
2012 2.41
2011 2.25
It is expected that to attract buyers, new common stock must be
underpriced $6 per share, and the firm must also pay $2.00 per
share in flotation costs. Dividend payments are expected to
continue at 50% of earnings. (Assume that rr =
rs)
a. The after-tax cost of debt using the bond's yield to
maturity (YTM) is? (Round to two decimal places.)
-The after-tax cost of debt using the approximation formula is?
(Round to two decimal places.)
b. The cost of preferred stock is? (Round to two decimal
places.)
c. The cost of retained earnings is? (Round to two decimal
places.)
-The cost of new common stock is? (Round to two decimal
places.)
d. Using the cost of retained earnings, the firm's WACC is?
(Round to two decimal places.)
Using the cost of new common stock, the firm's WACC is? (Round to
two decimal places)