1. A company will issue new common stock to finance an expansion. The existing c
ID: 2651233 • Letter: 1
Question
1. A company will issue new common stock to finance an expansion. The existing common stock just paid a $1.50 dividend, and dividends are expected to grow at a constant rate 8% indefinitely. The stock sells for $45, and flotation expenses of 5% of the selling price will be incurred on new shares. What is the cost of new common stock?
2. A company has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of common equity, based upon current market values. The yield to maturity on its bonds is 7.4%, and investors require 8% return on the company’s preferred and 14% return on the common stock. If the tax rate is 35%, what is the current WACC of this company?
3. Assume that you are on the financial staff of a company, and you have collected the following data: (1) The yield on the company’s outstanding bonds is 8.00%, and its tax rate is 40%. (2) The next expected dividend is $0.65 a share, and the dividend is expected to grow at a constant rate of 6.00% a year. (3) The price of the common stock is $17.50 per share, and the flotation cost for selling new shares is F = 10%. (4) The target capital structure is 45% debt and the balance is common equity. What is the current WACC of this company?
4. Assume that you are on the financial staff of a company, and you have collected the following data: (1) The yield on the company’s outstanding bonds is 8.00%, and its tax rate is 40%. (2) The next expected dividend is $0.65 a share, and the dividend is expected to grow at a constant rate of 6.00% a year. (3) The price of the common stock is $17.50 per share, and the flotation cost for selling new shares is F = 10%. (4) The target capital structure is 45% debt and the balance is common equity.
What will be the WACC if it must issue new stock to finance its capital budget maintaining the proportions of its capital structure?
Explanation / Answer
Answer:
Cost of New common Stock =[ Expected Dividend / (Price – Floatation cost)] + growth rate
Expected Dividend = Current Divided *(1+Growth rate) = 1.5 * (1+0.08) = 1.62
=[1.62/ (45 -45*5%)] + 0.08
=(1.62 / 42.75) + 0.08
= 0.1179
=11.79%
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