Vosberg, Inc wants to calculate the component costs in its capital structure. Co

Question

Vosberg, Inc wants to calculate the component costs in its capital structure. Common stock currently sells for $33, and is expected to pay a dividend of $.40. Vosberg's dividend growth rate is 8%, and flotation cost is $1.25. Preferred stock sells for $40, pays a dividend of $3.00, and carries a flotation cost of $1.10. Vosberg’s bonds yield 7% in the market. Vosberg is in the 30% tax bracket.
Calculate cost of debt, cost of new common stock, cost of preferred stock and cost of retained earnings.

Explanation / Answer

Cost of debt (after tax) = bonds yield*(1-tax rate)

Cost of debt (after tax) = 7%*(1-30%)

Cost of debt (after tax) = 4.90%

Cost of new common stock = Expected Dividend/(Stock price - Floatation Cost) + growth rate

Cost of new common stock = 0.40/(33-1.25) + 8%

Cost of new common stock = 9.26%

Cost of preferred stock = Dividend/ (Preferred stock price-flotation cost )

Cost of preferred stock = 3/(40-1.10)

Cost of preferred stock = 7.71%

Cost of retained earnings =  Expected Dividend/Stock price + growth rate

Cost of retained earnings =  0.40/33 + 8%

Cost of retained earnings = 9.21%

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