Ajax, Inc. is expecting to issue new debt at par with a coupon rate of 6%, and t

Question

Ajax, Inc. is expecting to issue new debt at par with a coupon rate of 6%, and to issue new preferred stock with a $2.00 per share dividend at $20 a share. Common stock is currently selling for $25 a share. Ajax expects to pay a dividend of $2.50 per share next year, and a market analysis indicates dividends will grow at a rate of 3% per year. The marginal tax rate is 40%.

If Ajax raises capital using a capital structure of 40% debt, 10% preferred stock and 50% common stock, what is the cost of capital for Ajax, Inc.?

Please show work. Thanks

Explanation / Answer

Before tax cost of debt * 1 - tax rate = 6*.6 = 3.6% preferred stock cost = dividend/price = 2/20 = 10% =(Expected Dividend (2.5)/Market Price (25)+ Growth rate (3%) = 13% now multiply by their weights: 3.6*.4+.1*.1+.13*.5=8.94%

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