Question

In: Finance

Given the following information: Percent of capital structure: Preferred stock 20 % Common equity (retained earnings)...

Given the following information:


Percent of capital structure:

Preferred stock 20 %
Common equity (retained earnings) 50
Debt 30

Additional information:

Corporate tax rate 40 %
Dividend, preferred $ 7.00
Dividend, expected common $ 3.50
Price, preferred $ 98.00
Growth rate 8 %
Bond yield 10 %
Flotation cost, preferred $ 3.40
Price, common $ 86.00

Calculate the weighted average cost of capital for Digital Processing Inc. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
  

Weighted Cost
Debt %
Preferred stock
Common equity (retained earnings)
Weighted average cost of capital 0.00 %

Solutions

Expert Solution

Weighted cost of each source of capital

Weighted Cost

Debt

1.80%

Preferred Stock

1.48%

Common Equity

6.04%

Weighted average cost of capital     

9.32%

Cost of Debt

Cost of Debt = Bonds Yield x (1 – Tax Rate)

= 10% x (1 – 0.40)

= 10% x 0.60

= 6.00%

Weighted Cost = 1.80% [6.00% x 0.30]

Cost of Preferred Stock

Cost of Preferred Stock = Preferred Dividend / [Price of Preferred stock – Flotation cost]

= [$7.00 / ($98 - $3.40)]

= [$7.00 / $94.60]

= 0.0740

= 7.40%

Weighted Cost = 1.48% [7.40% x 0.20]

Cost of Common Stock

Cost of Common Stock = [D1 / P0] + g

= [$3.50 / $86.00] + 0.08

= 0.0407 + $0.08

= 0.1207

= 12.07%

Weighted Cost = 6.04% [12.07% x 0.50]

Weighted Average Cost of Capital

= Weighed Cost of Debt + Weighted Cost of Preferred stock + Weighted cost of Common Stock

= 1.80% + 1.48% + 6.04%

= 9.32%

“Hence, the weighted average cost of capital for Digital Processing Inc would be 9.32%”


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