Given the following information about a company; The before tax cost of debt (rd

Question

Given the following information about a company; The before tax cost of debt (rdBT) = 9% The corporate tax rate (T_0) = 33% The annual preferred stock dividend (D_ps) = $2.00 Flotation costs of preferred stock (F) = 3% The preferred stock price is = $25.00 Beta(B) = 1.5 The riskfree rate (r_RF) = 4% The rate-of-return on the market (r_M) = 10% What is the cost of equity? (r_s) What is the after-tax cost of debt (r_dAT)? What is the cost of preferred stock? (r_ps)? If the company has a target of 20% debt capital and 80% common stock capital, what is the weighted average cost of capital?

Explanation / Answer

Cost of equity = risk free return + beta*(market rate of return – risk free return)

= 4% + 1.5*(10-4)

(rs)= 13%

Cost of preferred = dividend/price of preferred stock/(1-flotation cost)

= 2/25/(1-0.03)

(rps)= 7.76%

Cost of debt = interest*(1- tax)

= 9% *(1-0.33)

(rdAT)= 6.03%

Weighted average cost of capital = cost of equity * weight of equity + cost of debt * weight of debt

= 13% * .80 + 6.03* .20

= 11.606 %

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