Question

Show each step clearly. The problem should be approached by first computing the cost of the different components of capital. Merely writing the answers or skipping crucial steps will not earn partial credit.

Royce Manufacturing must calculate its weighted average cost of capital in order to evaluate new investment opportunities. The firm will raise $250,000,000 for a new manufacturing plant. Of this amount, $110,000,000 will be in the form of debt, $90,000,000 in new preferred stock, and the remaining capital will be from the issuance of common stock.

a. Royce has just issued bonds with a 9% coupon rate. The bonds, which mature 20 years from now, were sold at 84.1% of par. The firm is in the 35% marginal tax bracket. 10 points

b. Preferred stock with a preferred dividend of $9.25 per share can be issued at a price of $68 with a $2.50 flotation cost. 5 points

c. Royce currently pays a dividend of $1.80 per share and expects dividends to grow at 4% per year for the foreseeable future. The firm's common stock is currently trading at $46.75. New shares will carry a 5% issuance cost. 10 points

d. Calculate the weighted average cost of capital for Royce Manufacturing. 5 points

Answer 1