Question

Longstreet Communications Inc. (LCI) has the following capital structure, which it considers to be optimal: debt = 25%, preferred stock = 15%, and common equity = 60%. LCI’s tax rate is 40%, and investors expect earnings and dividends to grow at a constant rate of 6% in the future. LCI paid a dividend of $3.68 per share last year (D0) and its stock currently sells at a price of $60 per share. Ten-year Treasury bonds yield 6%, the market risk premium is 5%, and LCI’s beta is 1.3. The following terms would apply to new security offerings. Debt: New debt could be sold at par with a coupon rate of 9%. New debt with a face value of $1,000 will mature in 10 years. Interest is paid semiannually. Ignore flotation costs. Preferred stock: New preferred stock could be sold to the public at a price of $100 per share, with a dividend of $9. Flotation cost of $5 per share would be incurred. Common equity: New common equity can be raised either by retaining earnings or by issuing new common stock. The flotation cost for new common stock issuance is 8%. Use the judgmental risk premium of 3.5% for the Bond-Yield-Plus-Risk-Premium method.

What is LCI's after-tax cost of debt?

What is LCI's cost of preferred stock considering flotation costs?

What is LCI's cost of internal equity using the capital asset pricing model (CAPM) approach?

What is the firm's cost of internal equity using the discounted cash flow (DCF) approach ignoring flotation costs?

What is LCI's cost of internal equity using the bond-yield-plus-risk-premium approach?

What is LCI's cost of external equity using the discounted cash flow (DCF) approach considering flotation costs?

What is LCI's WACC when common equity is raised by retaining earnings? What is LCI's WACC when common equity is raised by issuing new common stock?

Answer 1

FOR CALCULATION OF WACC, WE HAVE TAKEN DCF APPROACH FOR ke