Calculation of the cost of the components in capital structure: After tax cost o

Question

Calculation of the cost of the components in capital structure:
After tax cost of debt = Cost of debt of 7.5% bond + Cost of debt of 4% bond
= Yield (1-tax rate) of 7.5% bond + Yield (1-tax rate) of 4% bond

K of 7.5% bond = 9% (1-0.30) = 0.09(0.70) = 0.063 or 6.3%
K of 4% bond = 10% (1-0.30) = 0.10(0.70) = 0.07 or 7%

Calculation of dividend = Dividend rate x Par value of the stock
= 0.05 x $15
= $0.75

Cost of preferred stock = Dividend of preferred stock .
Price of preferred stock – selling cost
rp = Dp . = 0.75 . = 0.1875 or 18.75%
Pp – F 12 – 8

Cost of common equity in the form of retained earnings
rs =Risk free rate + (expected market return – Market risk premium) x Beta
= rRF + (RPm)bi = rRF + (rm - rRF)bi
= 2% + (10% - 2%)1.25 = 0.02 + (0.08)1.25 = 0.02 +0.10 = 0.12 or 12%


Cost Weight Weighted Cost
Debt For 7.5% Bonds 6.30% 15% 0.945%
Debt For 4% Bonds 7% 15% 1.05%
Preferred Stock 18.75% 10% 1.875%
Common Equity (Retained Earnings) 12% 60% 7.20%
Weighted Average Cost Of Capital 11.07%

Here, we have calculated a WACC of 11.07%.

Conclusion
With the calculations and data provided, Riley Brothers should/should not proceed with the expansion project at this time.

Explanation / Answer

AS wACC is 11.5% they can continue their business but taking risk factors, equity and stock into consideration it would be better if they do not continue their business and stop it now.

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