Burton currently has $850,000 of long term debt outstanding, 5000 shares of pref

Question

Burton currently has $850,000 of long term debt outstanding, 5000 shares of prefered stock ($10 par) with a market price of $12 and 20,000 shares common stock ($20 par) with a market price of $53 a share. They used a WACC of 12% in the past to evaluate projects but want to determine their required return for new investments.

Debt: Burton can sell a 10-year, $1000 par value, 7% annual coupon bond for $975. A flotation cost of 2% of face (par) value would be required. Additionally, the firm has a marginal tax rate of 34%

Prefered Stock: Burton pays $1 dividens annually on their prefered shares. The shares are currently selling for for $12 in the secondary market. They do not have plans to issue any additional prefered stock.

Common Stock: Burtons common stock is currently selleing for $53 per share. The dividens exxpected to be paid at the end of the comming year is $4. Its dividens ayments have been growing at a cosntant %3 rate. It is expected that to sell all the shares, a new common stock issue must be underpriced $1 per share and the firm must pay %1 of the market value per share in flotation costs.

a. Caluclate the after-tax cost of debt.

b. Calculate the cost of prefered equity.

c.Calculate the cost of common equity

d. Calculate the WACC

Explanation / Answer

Amount of debt 850000 A Preferred Stock=5000*12 60000 B Common Stock=20000*53 1060000 C Cost of Bond=((1000*0.07)/(975-20))*(1-0.34)*100 4.838 X Cost of preferred Stock=(1/12)*100 8.333 Y Cost of Common Stock=(DIV/P)+g=(4/(53-1-0.53)+0.03)*100 10.772 Z WACC=(A*X+B*Y+C*Z)/(A+B+C) 8.137

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