Question

Calculation of individual costs and WACC   Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The firm is in the

30​%

tax bracket.

Debt  The firm can raise debt by selling

​$1,000​-par-value,

7​%

coupon interest​ rate,

16​-year

bonds on which annual interest payments will be made. To sell the​ issue, an average discount of

​$20

per bond would have to be given. The firm also must pay flotation costs of

​$25

per bond.

Preferred stock  The firm can sell

7.5​%

preferred stock at its

​$100​-per-share

par value. The cost of issuing and selling the preferred stock is expected to be

​$6

per share. Preferred stock can be sold under these terms.

Common stock  The​ firm's common stock is currently selling for

​$65

per share. The firm expects to pay cash dividends of

​$7

per share next year. The​ firm's dividends have been growing at an annual rate of

6​%,

and this growth is expected to continue into the future. To sell new shares of common​ stock, the firm must underprice the stock by

​$5

per​ share, and flotation costs are expected to amount to

$ 3

per share. The firm can sell new common stock under these terms.

Retained earnings  When measuring this​ cost, the firm does not concern itself with the tax bracket or brokerage fees of owners. It expects to have available

​$150,000

of retained earnings in the coming​ year; once these retained earnings are​ exhausted, the firm will use new common stock as the form of common stock equity financing

  the​ after-tax cost of debt 5.24

The​ after-tax cost of debt using the​ bond's yield to maturity​ (YTM) is

nothing​ 5.24%

Calculation of individual costs and WACC   Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The firm is in the

30​%

tax bracket.

Debt  The firm can raise debt by selling

​$1,000​-par-value,

7​%

coupon interest​ rate,

16​-year

bonds on which annual interest payments will be made. To sell the​ issue, an average discount of

​$20

per bond would have to be given. The firm also must pay flotation costs of

​$25

per bond.

Preferred stock  The firm can sell

7.5​%

preferred stock at its

​$100​-per-share

par value. The cost of issuing and selling the preferred stock is expected to be

​$6

per share. Preferred stock can be sold under these terms.

Common stock  The​ firm's common stock is currently selling for

​$65

per share. The firm expects to pay cash dividends of

​$7

per share next year. The​ firm's dividends have been growing at an annual rate of

6​%,

and this growth is expected to continue into the future. To sell new shares of common​ stock, the firm must underprice the stock by

​$5

per​ share, and flotation costs are expected to amount to

$ 3

per share. The firm can sell new common stock under these terms.

Retained earnings  When measuring this​ cost, the firm does not concern itself with the tax bracket or brokerage fees of owners. It expects to have available

​$150,000

of retained earnings in the coming​ year; once these retained earnings are​ exhausted, the firm will use new common stock as the form of common stock equity financing

  the​ after-tax cost of debt 5.24

ytm 5.24

 Calculate the cost of preferred stock.7.98

Calculate the cost of common stock 16.77

The cost of new common stock is

nothing​ 18.28

 Calculate the​ firm's weighted average cost of capital using the capital structure weights shown in the following​ table

Source of capital	Weight
​Long-term debt	35	​%
Preferred stock	25
Common stock equity	40
Total	100	​%

Round answer to the nearest​ 0.01%)

Answer 1

A) Calculation of cost of preferred stock

Dividend Payment = 7.5%

Par Value / Issue Price= $ 100

Dividend outflow = 7.5% of 100 = $ 7.5

Cost of issue per share = $ 6

Net Proceeds = 100 -6 = $ 94

Cost of Preferred stock = Dividend outflow / Net Proceeds

= 7.5/94 = 7.98%

B) For Calculation of Cost of Common stock we can use Gordon Growth's Model

where formula is

Share price = Dividend next year / (Cost of Equity - Growth rate)

Share Price = $ 65 Dividend Next year is $ 7 and Growth rate is 6%

By interchanging the formula we can calculate the cost of equity as

Cost of Equity = Dividend/ Share Price + Growth

= 7/65 + 6%

= 10.77% + 6% = 16.77%

Now in order to raise new capital , share price must be reduced by $ 5 per share and floatation cost will be $ 3 per share

therefore net proceeds will be $ 57 per share

Therefore new cost of equity is 7/57 + 6 % = 12.28% + 6 % = 18.28%

Details	Weights	Cost (%)	Weight*Cost
Debt	35%	5.24	1.834
Preferred Stock	25%	7.98	1.995
Common Stock	40%	18.28	7.312
Total (Weighted Average Cost of Capital)			11.14