Question

What is the cost of debt, preferred stock and common equity for Forecasters R US? What is the WACC: The firm is in the 40% tax bracket. The optimal capital structure is listed below: Briefly discuss your results and what they represent.

Source of Capital	Weight
Long-Term Debt	25%
Preferred Stock	20%
Common Stock	55%

Debt: The firm can issue $1,000 par value, 8% coupon interest bonds with a 20-year maturity date. The bond has an average discount of $30 and flotation costs of $30 per bond. The selling price is $1,000.

Preferred Stock: The firm can sell preferred stock with a dividend that is 8% of the current price. The stock costs $95. The cost of issuing and selling the stock is expected to be $5 per share.

Common Stock: The firm’s common stock is currently selling for $90 per share. The firm expects to pay cash dividends of $7 per share next year. The dividends have been growing at 6%. The stock must be discounted by $7 and flotation costs are expected to amount to $5 per share.

Answer 1

Weight of equity = E/A

Weight of equity =

W(E)=0.55

Weight of debt = D/A

Weight of debt = 0.25

W(D)=0.25

Weight of preferred equity =1-D/A-E/A

Weight of preferred equity = =1-0.25 - 0.55

W(PE)=0.2

Cost of equity

As per DDM

Price-flotation cost Dividend in 1 year/(cost of equity - growth rate)

78-12 = 7/ (Cost of equity - 0.06)

Cost of equity% = 14.97

Cost of debt

K = N

Bond Price -flotation cost =∑ [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N

k=1

K =20

940-60 =∑ [(8*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^20

k=1

YTM = 8.6405273415

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 8.6405273415*(1-0.4)

= 5.1843164049

cost of preferred equity

cost of preferred equity = Preferred dividend/price-flotation cost*100

cost of preferred equity = 7.6/(90-5)*100

=8.44

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=5.18*0.25+14.97*0.55+8.44*0.2

WACC =11.22%