Question

Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The firm is in the 21​% tax bracket.

Debt: The firm can raise debt by selling 1,000​-par-value, 8​% coupon interest​ rate, 20​-year bonds on which annual interest payments will be made. To sell the​ issue, an average discount of

​$30 per bond would have to be given. The firm also must pay flotation costs of $30 per bond.

Preferred stock: The firm can sell 8​% preferred stock at its $95​-per-share par value. The cost of issuing and selling the preferred stock is expected to be $5 per share. Preferred stock can be sold under these terms.

Common stock: The​ firm's common stock is currently selling for $90 per share. The firm expects to pay cash dividends of $7 per share next year. The​ firm's dividends have been growing at an annual rate of 6%, and this growth is expected to continue into the future. The stock must be underpriced by $7 per​ share, and flotation costs are expected to amount to $ 5 per share. The firm can sell new common stock under these terms.

Retained earnings: When measuring this​ cost, the firm does not concern itself with the tax bracket or brokerage fees of owners. It expects to have available 100,000

of retained earnings in the coming​ year; once these retained earnings are​ exhausted, the firm will use new common stock as the form of common stock equity financing.

a.  Calculate the​ after-tax cost of debt.

b.  Calculate the cost of preferred stock.

c.  Calculate the cost of common stock.

d.  Calculate the​ firm's weighted average cost of capital using the capital structure weights shown in the following​ table,

Long-term debt   30%
Preferred stock   20%
Common stock equity   50%
Total   100%

Answer 1

		AMOUNT IN $
	PARTICULRAS
	TAX	21%
	DEBT
	PAR VALUE	1000
	INTEREST	8%
	20 YEAR BOND
	DISCOUNT	30
	FLOTATION	30
	NET PROCEEDS	940
A	COST OF DEBENTURE	I(1-TAX)+(RV-NV)/20/(RV+NV)/2
	I INTEREST	8%
	RV - PAR VALUE	1000
	NV-NET PROCEEDS	940
	(80*(1-21%)+(1000-940))/20/(1000+940)/2	6.82%
B	COST OF PREFERENCE SHARE
	COST OF PREFERENECE CAPITAL	DIVIDEND +(RV-NV)/N/(RV+NV)/2
	RV-PAR VALUE	95
	DIVIDEND -8%	7.6
	ISSUE EXPENSE	5
	NV	90
	COST OF PREFERENCE CAPITAL	DIVIDEND/NET PROCEEDS
		7.60/90
		8.44%
C	COST OF EQUITY CAPITAL
	SELLING PRICE	90
	UNDER PRICE	7
	FLOTATION	5
	NET PRICE	78
	DIVIDEND NEXT YEAR	7
	GROWTH	6%
D	AS PER GROWTH MODEL
	PRICE	DIVIDEND/( COST OF CAPITA-GROWTH)
		78=7/(COST OF CAPITAL-6%)
		78*COST OF CAPITAL -78*6%=7
		11.68/78
		14.97%
	WACC	WEIGHT	COST OF CAPITAL
	EQUITY	50	14.97%	7.49%
	PREFERNCE SHARE	20	8.44%	1.69%
	DEBENTURE	30	6.82%	2.05%
	WEIGHTED AVERAGE COST OF CAPITAL			11.22%