The Imaginary Products Co. currently has debt with a market value of $300 millio

Question

The Imaginary Products Co. currently has debt with a market value of $300 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $839.36 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $21. The preferred shares pay an annual dividend of $1.20. Imaginary also has 14 million shares of common stock outstanding with a price of $20.00 per share. The firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 8 percent per year forever. If Imaginary is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital?

Calculate the Weights for debt, common equity, and preferred equity. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Explanation / Answer

Market value Weights Common stock $ 300,000,000 48.23% Debt $    42,000,000 6.75% 2000000*21 Preferred stock $ 280,000,000 45.02% 14000000*20 Total $ 622,000,000 100.00%

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