Question

Edna Recording​ Studios, Inc., reported earnings available to common stock of

​$5,000,000

last year. From those​ earnings, the company paid a dividend of

​$1.15

on each of its

1,000,000

common shares outstanding. The capital structure of the company includes

45​%

​debt,

10​%

preferred​ stock, and

45​%

common stock. It is taxed at a rate of

30​%.

 If the market price of the common stock is

​$31

and dividends are expected to grow at a rate of

9​%

per year for the foreseeable​ future, what is the​ company's cost of retained earnings

financing​ 13.04

 If underpricing and flotation costs on new shares of common stock amount to

​$7

per​ share, what is the​ company's cost of new common stock

financing​ 14.22

The company can issue

​$1.65

dividend preferred stock for a market price of

​$35

per share. Flotation costs would amount to

​$5

per share. What is the cost of preferred stock

financing​ 5.50

The company can issue

​$1,000​-par-value, 6​%

​coupon,

14​-year

bonds that can be sold for

​$1,160

each. Flotation costs would amount to

​$25

per bond. Use the estimation formula to figure the approximate​ after-tax cost of debt​financing 3.30

 Using the cost of retained​ earnings,

r Subscript rrr​,

the​ firm's WACC,

r Subscript ara​,

is

nothing​ 7.90

Using the cost of new common​ stock,

r Subscript nrn​,

the​ firm's WACC,

r Subscript ara​,

is

nothing​%

Answer 1

1) Price per equity share = Dividend * (1+growth rate in dividend) / (Cost of equity - growth rate in dividend)

31 = 1.15 * (1+9%) / (Cost of equity - 9%)

Cost of equity = (1.15 * 1.09) / 31 + 9%

Cost of equity = 13.04%

For new under pricing and flotation cost was $7 per share

Effective share price = 31 -7 = $24

  Cost of equity = (1.15 * 1.09) / 24 + 9%

   Cost of equity = 14.22%

2) Cost of preference share = dividend per share / (preference share price - flotation cost)

= 1.65 / (35 -5)

Cost of preference share = 5.5%

3) Bond after tax cost

Market price of bond = 1,160 , Flotation cost = 25 , Net market price of bond = 1160-25 = 1,135

Face value = 1000, Tenure = 14, Coupon = 6%

Using excel formula , Yield = =RATE(14,60,-1135,1000)

Cost of debt = 4.67%

After tax cost of debt = 4.67% * (1-30%) = 3.3%

4) WACC

a) based on cost of old equity = 13.04%

WACC = equity weight * cost of equity + debt weight * after tax cost of debt + preference share cost * weight of preference shares

= 45% * 13.04% + 45% *3.3% + 10% * 5.5%

WACC = 7.9%

b) based on cost of new equity = 14.22%

WACC = equity weight * cost of equity + debt weight * after tax cost of debt + preference share cost * weight of preference shares

= 45% * 14.22% + 45% *3.3% + 10% * 5.5%

WACC = 8.4%