Question

Problem 13.24 a1-a5 The Imaginary Products Co. currently has debt with a market value of $300 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 $1,440.03 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. Imaginary 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 5 percent per year forever. If Imaginary is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital? 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%.) WACC %

Answer 1

2. Cost of Debt

YTM
Semi-Annual Payment
Period	30	Period (15 * 2)
Payment	$         45.00	Semi Annual Coupon
Price of Bond	$ (1,440.03)
Future Value	$   1,000.00
Semi-Annual YTM	2.42%	RATE(30,45,-1440.03,1000)
Annual Cost of Debt	4.84%	2.42% * 2
After Tax Cost of Debt	2.90%	4.84%*(1 - 40%)

3. Cost of preferred Stock

Cost of preferred Stock = Dividend / Price = 1.20 / 12 = 10.00%

4. Cost of equity = [Annual Dividend / Price] + growth rate

Cost of equity = [2.20 / 20] + 0.05

Cost of equity = 16%

1.Weights and WACC