Dillon Labs has asked its financial manager to measure the cost of each specific
ID: 2634725 • Letter: D
Question
Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 40% long-term debt, 10% preferred stock, and 50% common stock equity (retained earning, new common stock, or both). The firm's tax rate is 40%.
The firm can sell for $980 a 10-year, $1000 par-value bond paying annual interest at a 10% coupon rate. A flotation cost of 3% of the par value is required in addition to the discount of $20 per bond.
The firm's common stock is currently selling for $50 per share. The dividend expected to be paid at the end of the coming year (2016) is $4. Its dividend payments, which have been approximately 60% of earnings per share in each of the past 5 years, were as shown in the following table.
It is expected that to attract buyers, new common stock must be underpriced $5 per share, and the firm must also pay $3 per share in flotation costs. Dividend payments are expected to continue at 60% of earnings. (Assume that rr = rs.)
DebtThe firm can sell for $980 a 10-year, $1000 par-value bond paying annual interest at a 10% coupon rate. A flotation cost of 3% of the par value is required in addition to the discount of $20 per bond.
Preferred stock Eight percent (annual dividend) preferred stock having a par value of $100 can be sold for $65. An additional fee of $2 per share must be paid to the underwriters. Common StockThe firm's common stock is currently selling for $50 per share. The dividend expected to be paid at the end of the coming year (2016) is $4. Its dividend payments, which have been approximately 60% of earnings per share in each of the past 5 years, were as shown in the following table.
Year Dividend 2015 $3.75 2014 $3.50 2013 $3.30 2012 $3.15 2011 $2.85It is expected that to attract buyers, new common stock must be underpriced $5 per share, and the firm must also pay $3 per share in flotation costs. Dividend payments are expected to continue at 60% of earnings. (Assume that rr = rs.)
a. Calculate the after-tax cost of debt. Finding the YTM on a Bond Net proceeds from sale of bond $ Coupon payment $ Years to maturity Par value (principal) $ Before-tax cost of debt % After-tax cost of debt % b. Calculate the cost of preferred stock. Cost of Preferred Stock Annual dividend $ Net proceeds $ Cost % c. Calculate the cost of common stock. INTEREST OR GROWTH RATE - SERIES OF CASH FLOWS Cost of new common stock - Constant Growth Model Annual growth rate % Year Cash Flow Next year dividend $ 2008 $2.85 Current price $ 2012 $3.75 Cost of new common stock % Annual Growth Rate 7.10% d. Calculate the WACC for Dillon Labs. Cost of new common stock % Weight of common stock % Weighted cost of retained earnings % Cost of preferred stock % Weight of preferred stock 1.00% Weighted cost of preferred stock 1.000% Before tax cost of debt % After-tax cost of debt - 25% % Weight of debt % Weighted cost of debt % Weighted Average Cost of Capital Weighted cost of retained earnings % Weighted cost of preferred stock % Weighted cost of debt % %Explanation / Answer
a. 9.4(1-.4)%=5.6%
b. rs=($4/$50.00) + 7.10%
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