the corp tax rate is 30%.+the bond is a 10 year, 8% coupon rate, $1000 par value

Question

the corp tax rate is 30%.+the bond is a 10 year, 8% coupon rate, $1000 par value, selling at $1150 today. The current price of ABC stock is $55 per share, current dividends are $2.62 and are expected to increase to $2.80 per share next year. Costs are associated with new issue of common stock are estimated at 5% or $2.75 per share and stock can be priced at its current price of $55.00. ABC Corp has the following capital structure. debt(bond)=$5,000, retained earnings=$12000, common stock=$8,000, total=25,000. 1. What is the cost of retained earnings for abc corp? 2. what is the cost of new common stock for ABC? 3. What is the weighted average cost of capital of ABC corp?

Explanation / Answer

Cost of retained earning=(D1/P0)+g , wher D1=Divided next year , P0=Current Price , g=Growth Rare Here, D1=2.80 , P0=55 , g=(2.80/2.62)-1=1.0687-1=0.0687 Cost of retained earning=(D1/P0)+g =(2.80/55)+0.0687=0.1196 or 11.96% Cust of new common stock=Cost/Price=2.75/55=0.05 or 5% YTM of Bond=[C+(M-P)/n]/(0.4M+0.6P) Here, C=8% of 1000=80 M=1000 , P=1150 , n=10 YTM of Bond=[C+(M-P)/n]/(0.4M+0.6P)=(80+(1000-1150)/10)/(0.4*1000+0.6*1150)=0.059 or 5.9% WACC=Sum of [ Proportion of each capital * Cost of that capital ] WACC=(5000/25000)*5.9+(12000/25000)*11.96+(8000/25000)*5=8.52%

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