Question

Target Market
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

Ans.

After tax cost of Debt

Par Value = $ 1,000

Price = $950

Flotation rate = 3%

Flotation Cost = Par value * Flotation rate = $ 1,000 * 3% = $ 30

Current Price after flotation cost = $950 - $30 = $920

Time Period = 10Years

Coupon rate = 7%

Coupon Amount = $ 1,000 * 7% = $70

YTM =[ C + (F-P) / n] / [(F+P)/2]

YTM = 70 + ( 1000 - 920) / 10 / [(1000 + 920)/2]

YTM = 78 / 960 = 8.125% (approximately)

And exactly it is 8.2%

So After tax cost of debt = 8.2% - 20% = 6.56%

Cost of Preferred Stock

Annual Dividend = $ 6.5

Current Price =$ 45

cost of issuing and selling = $ 2.5

Cost of Preferred Stock = Annual Dividend / (Current Price - cost of issuing and selling )

= $6.5 / ($45 - $ 2.5) = 15.29%

Cost of Equity

Dividend ( 5 years ago) = $ 1.45

Flotation Cost = $ 2 + $ 0.75 = $ 2.75

Expected Dividend = $ 3.75

Number of Years = 6

Growth rate = (3.75/1.45)^1/6 - 1 = 1.1716 -1 = 17.16%

Price = $ 25

Cost of Equity =Expected Dividend / ( Price - Flotation cost) + Growth rate

= $ 3.75/ ($ 25 - $ 2.75) + 17.16% = 34.01%

WACC = Weight of Debt * Cost of Debt + Weight of Preferred Stock * Cost of Preferred Stock + Weight of Equity * Cost of Equity

WACC = 30% * 6.56 + 5% * 15.29 + 65% * 34.01

= 1.968% + 0.7645% + 22.1065 %= 24.839%