Question

Capital Asset Pricing: XYZ Inc. has the following information:

Total Market Value of Long-Term Debt: $900,000; Weight 37%

Total Market Value of Preferred Stock: $30,000; Weight 1.2%

Total Market Value of Common Stock: $1,500,000; Weight 61.7%

Tax Rate= 21% YTM on Bonds= 7.8%

Annual Preferred Dividend= $4.75

Preferred Stock Price= $41

Flotation Costs on Issuance of New Preferred Stock= 4%

Next Year’s Expected Common Stock Dividend= $2.25

Current Common Stock Price= $49

Expected Dividend Growth Rate= 6.5%

1) Compute the cost of preferred stock

2) Compute the cost of common stock

3) Compute the Weighted Average Cost of Capital (WACC)

Answer 1

1)Cost of preferred stock = Annual preferred dividend /price(1-Flotation cost)

            = 4.75/41(1-.04)

            = 4.75 / 39.36

            = 12.07%

2)cost of common stock = [D1/price] +g

                = [2.25/49]+.065

                = .0459+.065

                = .1109 or 11.09%

3)Total capital : 900000+30000+1500000=2430000

Capital structure	cost	weight	weight *cost
After tax cost of debt	7.8[1-.21]= 6.162	900000/2430000= 37.04%	2.28
Preferred stock	12.07	30000/2430000=1.23%	.15
common stock	11.09	1500000/2430000= 61.73%	6.85
		WACC	9.28%