A company has a capital structure of 45% debt, 5% preferred stock and 50% common
ID: 2491228 • Letter: A
Question
A company has a capital structure of 45% debt, 5% preferred stock and 50% common equity.
(a) The company can obtain unlimited debt at an interest rate of 10%. The marginal tax rate is 35%. Find the after-tax cost of debt.
(b) Preferred stock carries a dividend of $14 and currently sells for $120.00. Flotation cost on preferred stock is $10 per share. What is the cost of preferred stock?
(c) Their current stock price is $25. The next dividend is expected to be $2.56 and growth is constant at 8%. If new common stock is issued, it will have a flotation cost of 10%. Find the cost of retained earnings and the cost of issuing new common shares.
(d) If the net income is expected to be $1,600,000, and the company’s policy is to pay 50% of net income for dividends, what is the break point caused by using all of retained earnings?
(e) Find the WACC using retained earnings and the WACC when new equity is issued.
A company has a capital structure of 45% debt, 5% preferred stock and 50% common equity.
(a) The company can obtain unlimited debt at an interest rate of 10%. The marginal tax rate is 35%. Find the after-tax cost of debt.
(b) Preferred stock carries a dividend of $14 and currently sells for $120.00. Flotation cost on preferred stock is $10 per share. What is the cost of preferred stock?
(c) Their current stock price is $25. The next dividend is expected to be $2.56 and growth is constant at 8%. If new common stock is issued, it will have a flotation cost of 10%. Find the cost of retained earnings and the cost of issuing new common shares.
(d) If the net income is expected to be $1,600,000, and the company’s policy is to pay 50% of net income for dividends, what is the break point caused by using all of retained earnings?
(e) Find the WACC using retained earnings and the WACC when new equity is issued.
Explanation / Answer
a) After-tax cost of debt =6.5% (10*(1-35%)
b)Cost of Preferred Stock = Dividend on Preferred/Price of Preferred-Flotation Costs)
=14/(120-10)*100
=12.73%
c) Cost of Equity (Ke) by using Growth model
Ke = D/Current market price + Growth
Ke =2.56/25+8%
=18.24%
Cost of Issuing New Common Shares (Re) = ($2.56/($25.00*(1-0.1))
=11.38%
d)break point caused by using all of retained earnings = $1,600,000*(1-.50)
=$ 8,00,000
E) WACC =18.24*50% +6.5*45%+12.73*5%
=12.68%
WACC when new equity is issued. =18.24*50% +6.5*45%+11.38*5%
=12.61%
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