The Argos Corp is planning to raise $20 million in capital to finance the expans

Question

The Argos Corp is planning to raise $20 million in capital to finance the expansion of their manufacturing plant. The break-up is as follows: 6 million in debt, 4 million in preferred stock and 10 million in common stock.

        a.     They plan to issue 10 years bonds, paying 10% coupon annually, and expect to receive $1031.40 per $1000 face value. Ignore floatation costs.

        b.     They plan to issue perpetual preferred stocks and expect to receive $73.62 per face value of $100 paying 12% preferred dividends. Ignore floatation costs.

        c.     The plan to issue common stock and expect to pay $2.40 in dividends next year (d1) with a forecasted growth rate of 7%. The current market price of the stock is $18.36.

What is the weighted average cost of capital (WACC) if the marginal tax rate is 30%?

Following up on Question 1, assume you would like to have the WACC equal to 14.75%. They believe they can change the dividend rate paid on their common stock without affecting the price of $18.36. What should be the approximate dividend payment in order for Argos to have WACC=14.75%

The question above is Question 1.

Explanation / Answer

Cost of debt (Kd) = [Interest*(1 - tax rate) + (Redeemable value - net issue price)/number of life of bond] / [(Redeemable value + net issue price)/2] = [100*(1 - 0.30) + (1000 - 1031.4)/10] / [(1000 + 1031.4)/2] = 6.58%

Cost of preferred stock (Kp) = 12/73.62 = 16.30%

Cost of equity (Ke) = (D1/P0) + g = (2.4 / 18.36) + 0.07 = 20.07

Weight of:
Equity = 10 / 20 = 50%
Preferred stock = 4 / 20 = 20%
Debt = 6 / 20 = 30%

WACC = (6.58*30%) + (16.30*20%) + (20.07*50%) = 15.27%

PART II

WACC = (6.58*30%) + (16.30*20%) + (Ke*50%)

14.75 = 1.974 + 3.26 + 0.5Ke

Ke = (14.75 - 1.974 - 3.26) / 0.5 = 19.032%

Ke = (D1/P0) + g

0.19032 = (D1 / 18.36) + 0.07

D1 = (0.19032 - 0.07)*18.36

D1 = $2.21 per share

Thus, to have WACC of 14.75%, dividend should be $2.21 per share

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