The target capital structure of Orange Corporation is 40 percent common stock, 1

Question

The target capital structure of Orange Corporation is 40 percent common stock, 10 percent preferred stock, and 50 percent debt.

Orange Corporation is issuing new common stock at a market price of $52. Dividends last year were $6.30 and are expected to grow at an annual rate of 6% forever. Flotation costs will be %5 per share.

Orange Corporation is issuing a bond. Before-tax cost of debt is 12.87%. The firm's tax rate is 34%.

The preferred stock of Orange Corporation sells for $49 and pays $4.90 in dividends. Flotation costs will be $5 per share.

a) What is Orange's cost of common equity?

b) What will be the Orange's after-tax cost of debt on the bond?

c) What is the Orange's cost of capital for the preferred stock?

d) What is the Orange's weighted average cost of capital?

PLEASE SHOW WORK

Explanation / Answer

a) What is Orange's cost of common equity?

As per DDM

Price = D1/(Ke-g)

(52-5%*52) = (6.30*1.06)/(Ke - 0.06)

49.40 = 6.678/(Ke- 0.06)

Ke = 6.678/49.40 + 0.06

Ke = 19.52%

Orange's cost of common equity = 19.52%

b) What will be the Orange's after-tax cost of debt on the bond?

Orange's after-tax cost of debt on the bond = Before-tax cost of debt* (1-tax rate)

Orange's after-tax cost of debt on the bond = 12.87*(1-0.34)

Orange's after-tax cost of debt on the bond = 8.49%

c) What is the Orange's cost of capital for the preferred stock?

Orange's cost of capital for the preferred stock = Dividend/ share price after flotation cost

Orange's cost of capital for the preferred stock = 4.90/(49-5)

Orange's cost of capital for the preferred stock = 4.90/44

Orange's cost of capital for the preferred stock = 11.14%

d) What is the Orange's weighted average cost of capital?

Orange's weighted average cost of capital = cost of capital for the preferred stock* Weight of preferred stock + After-tax cost of debt * Weight of Debt + cost of common equity* Weight of Common stock

Orange's weighted average cost of capital = 11.14*10% + 8.49*50% + 19.52*40%

Orange's weighted average cost of capital = 13.17%

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.