Question

Source of Capital	Proportions
Long-term debt	30%
Preferred stock	5%
Common stock equity	65%

Debt: The firm can sell a 10-year, $1,000 par value, 7 percent bond for $950. A flotation cost of 3percent of the par value would be required in addition to the discount of $50.
Preferred Stock: The firm has determined it can issue preferred stock at $45 per share par value. The stock will pay an $6.5 annual dividend. The cost of issuing and selling the stock is $2.5 per share.
Common Stock: The firm's common stock is currently selling for $25 per share. The dividend expected to be paid at the end of the coming year is $3.75. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $1.45. It is expected that to sell, a new common stock issue must be underpriced at $2 per share and the firm must pay $0.75 per share in flotation costs.
Additionally, the firm's marginal tax rate is 20 percent. Calculate the firm's weighted average cost of capital assuming the firm has exhausted all retained earnings.

Please solve not EXCEL

Answer 1

After-tax cost of debt, kd

Using the formula to find the present value of bonds,

Present value/Current market price of the bond=PV of future coupons+PV of face value at maturity

ie.PV/Price=(Pmt.*(1-(1+r)^-n)/r)+(FV/(1+r)^n)

where,PV/Price is the net proceeds, net of flotation costs, from issue, ie. 950-(3%*1000)= $ 920

Pmt.= The $ annual coupon --ie. 1000*7%= $ 70

r=Annual before-tax yield or effective interest rate--- to be found out----??

n= no.of years to maturity, ie. 10

FV=face value= $ 1000

Plugging-in the values in the formula,

ie.920=(70*(1-(1+r)^-10)/r)+(1000/(1+r)^10)=

Solving the above for r,we get the Annual before-tax yield/cost as

8.20319%

So, the after-tax cost= Before-tax cost*(1-Tax rate)

ie.8.20319%*(1-20%)=

6.56%

NOTE: As nothing to the contrary is given, Annual coupons assumed

Cost of Preferred stock, kps

kps=$ dividend/Net proceeds of issue

where,Net proceeds of issue=(Price-Cost of issuing & selling) per share

so, kps=6.5/(45-2.5)=

15.29%

Cost of common stock, ke

Foll.details are given:

Dividend expected to be paid at the end of the coming year is $3.75

Five years ago, the dividend was $1.45

So,We are in Yr.0

Dividend payments have been growing at a constant rate for the last five years

so, the constant growth g, of dividends, in these in-between 5 years is;

can be got by forming an equation as below,

1.45*(1+g)^6=3.75

solving g, we get the grwoth rate as

17.16%

NOTE: As nothing is told about the 6th year , growth rate calculated equating to $ 3 75 at this yr. end

Now, ke=(D1/P0)+g

where , D1= Next dividend, ie. $ 3.75

P0=Net proceeds of issue after under pricing & flotation cost,ie. 25-2-0.75= $ 22.75

g= 17.16% as found out above

so, ke=(3.75/22.75)+17.16%=

33.64%

Now, WACC= (Wt.d*kd)+(wt.ps*kps)+(Wt.e*ke)

ie.(30%*6.56%)+(5%*15.29%)+(65%*33.64%)=

24.60%

(ANSWER)