Dillon labs has asked its financial manager to measure the cost of each specific

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 m easured by using the following weights: 40% long term debt, 10% preferred stock ,and 50% seemed common stock or both. The firms tax rate is 40%. Debt: The firm can sell its bonds for $980.00. a 10 year . 1,000 par value bond paying annual interest at a 10% coupon rate. A floatation cost of 3% of the par value is required in addition to the discount of $20.00 per bond. Preferred stock: eight percent preferred stockhaving a par value of $100can be sold for $65. the underwritters.

a) Calculate the specific cost of each source of financing Assume that the requireds return of retained earnings is equal to that on common stock.

b) If earning is available to common shareholders are expected to be $7 million what is the break point associated with the exhaustion of retained earnings?

c) Determine the weighted average cost of capital between zero and the break point calculated in part b above.

d) Determine the weighted average cost of capital just beyond the break point calculated in part b.

Explanation / Answer

Since the detail of Equity Shares capital (Common Stock) and retained earning is missing in the question. I have not provided the cost of Equity Shares and cost of Retained Earning.

Cost of Debt and Prefered stock is as follows:

a)   Calculation of Specific Cost of each source of finance:

Cost of Debt (Bond)        =             Interest (1-Tax Rate) / Net Proceed x 100

                                                =             $100 (1

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