You are an assistant to the CFO and have collected the following data to conduct the analysis. The company is subjected to a marginal tax rate of 35%. The company can issue a 20-year, 7.6% semi-annual coupon bond at $1,219. New bonds would be privately placed with no floatation cost. The company’s preferred stock currently sells for $30 per share. It pays a fixed dividend of $1.8 per share. The company’s common stock currently sells for $40 per share. The most recently paid dividend was $1 per share. Dividends are expected to grow at a constant rate of 5% in the foreseeable future. A flotation cost of 10% would be required to issue new common stock. The company’s stock beta is 1.875, the market risk premium is 3% and the risk-free rate is 2%. The company’s capital structure consists of 30% debt, 5% preferred stock, and 65% common equity. (1) Estimate the cost of the following capital components Cost of Debt Cost of Preferred Stock Cost of Retained Earnings—based on DCF approach Cost of Retained Earnings—based on CAPM approach Cost of New Common Stock ---based on DCF approach (2) Calculate the firm’s WACC, assuming it does not want to issue new common stock. (3) Calculate the firm’s WACC, assuming the firm expands so rapidly that it must issue new common stock.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
You are an assistant to the CFO and have collected the following data to conduct the analysis.
- The company is subjected to a marginal tax rate of 35%.
- The company can issue a 20-year, 7.6% semi-annual coupon bond at $1,219. New bonds would be privately placed with no floatation cost.
- The company’s preferred stock currently sells for $30 per share. It pays a fixed dividend of $1.8 per share.
- The company’s common stock currently sells for $40 per share. The most recently paid dividend was $1 per share. Dividends are expected to grow at a constant rate of 5% in the foreseeable future.
- A flotation cost of 10% would be required to issue new common stock.
- The company’s stock beta is 1.875, the market risk premium is 3% and the risk-free rate is 2%.
- The company’s capital structure consists of 30% debt, 5% preferred stock, and 65% common equity.
(1) Estimate the cost of the following capital components
- Cost of Debt
- Cost of Preferred Stock
- Cost of
Retained Earnings —based on DCF approach - Cost of Retained Earnings—based on
CAPM approach - Cost of New Common Stock ---based on DCF approach
(2) Calculate the firm’s WACC, assuming it does not want to issue new common stock.
(3) Calculate the firm’s WACC, assuming the firm expands so rapidly that it must issue new common stock.
Trending now
This is a popular solution!
Step by step
Solved in 4 steps with 6 images
