3. The GOJO Steam Cleaning Corporation is preparing to purchase a new mobile ste

Question

3. The GOJO Steam Cleaning Corporation is preparing to purchase a new mobile steam cleaning fleet for $5,000,000. The proposed sources of capital are $2,000,000 from a bank loan, $500,000 from a bond issuance, $1,000,000 from a stock sale, and the remainder from retained earnings. The specifics for each source are listed below. GOJO is in a 21% tax bracket. Bank loan 15% before tax interest rate, payable in 5 equal annual payments 12% bond interest rate with quarterly payments and a 5 year maturity $5.00 dividends on a selling price of $50 per share Stock Sale a. What is the after tax cost of the bond capital? b. What is the after tax cost of the loan capital? C. What is the after tax cost of the stock capital? d. What is the after tax cost of the retained eamings capital? e. What is the weiahted averaae cost of capital

Explanation / Answer

New mobile cleaning fleet                            5,000,000 Proposed source of capital Amount % Bank Loan                            2,000,000 40% =2000000/5000000*100 Bond                                500,000 10% =500000/5000000*100 Stock Sale                            1,000,000 20% =1000000/5000000*100 Retained earning                            1,500,000 (5,000,000-2000,000-500,000-1,000,000) 30% =1500000/5000000*100 Tax Rate 21% A) After tax cost =Before tax cost*(1-t) 9.48% =12%*(1-0.21) B) After tax cost =Before tax cost*(1-t) 11.85% =15%*(1-0.21) C) Cost of Stock Capital=Dividend/Selling Price 10.00% =5/50 D) Cost of retained earning 10% E) WACC a b c=a*b Proposed source of capital % of total requirement After Tax cost Weighted Cost Bank Loan 40% 11.85% 4.74% Bond 10% 9.48% 0.95% Stock Sale 20% 10.00% 2.00% Retained earning 30% 10.00% 3.00% WACC 10.69%

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