Question

Problem 13.24 a1-a5 (Excel Video) The Blossom Products Co. currently has debt with a market value of $250 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $1,445.45 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $12 per share. The preferred shares pay an annual dividend of $1.20. Blossom also has 14 million shares of common stock outstanding with a price of $20.00 per share. The firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 6 percent per year forever. If Blossom is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital?

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Calculate the weights for debt, common equity, and preferred equity. (Round intermediate calculations and final answers to 4 decimal places, e.g. 1.2514.)

Debt

Preferred equity

Common equity

Calculate the cost of debt. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Cost of debt %

Calculate the cost of preferred equity. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Cost of preferred equity %

Calculate the cost of common equity. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 0 decimal places, e.g. 15%.)

Cost of common equity %

What is the firm’s weighted average cost of capital? (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Answer 1

1. Weights

Debt = 0.4513

Preferred Stock = 0.0433

Equity = 0.5054

2. Cost of Debt = Using Rate function we get before tax cost of 4.80%

After tax Cost of Debt = 4.80 * (1 - 40%) = 2.88%

3. Cost of Preferred Stock = Dividend / Market Price = 1.20 / 12 = 10.00%

4. Cost of Equity = (Dividend in Coming year / Market Price) + Growth Rate

Cost of Equity = (2.2 / 20) + 0.06 = 17.00%

5. WACC = 10.32%