Edna Recording Studios, Inc., reported earnings available to common stock of $4,

Question

Edna Recording Studios, Inc., reported earnings available to common stock of $4,000,000 last year Cost of capital From those earnings, the company paid a dividend of $1.31 on each of its 1,000,000 common shares outstanding. The capital structure of the company includes 35% debt, 10% preferred stock, and 55% common stock. It is taxed at a rate of 40% 10. a. If the market price of the common stock is $43 and dividends are expected to grow at a rate of 5% per year for the foreseeable future, what is the company's cost of retained earnings financing? b. If underpricing and flotation costs on new shares of common stock amount to $9 per share, what is the company's cost of new common stock financing? c. The company can issue $1.75 dividend preferred stock for a market price of $32 per share. Flotation costs would amount to $6 per share. What is the cost of preferred stock financing? d. The company can issue $1,000-par-value, 7% coupon, 14-year bonds that can be sold for $1,140 each. Flotation costs would amount to $35 per bond. Use the estimation formula to figure the approximate after-tax cost of debt financing? e. What is the WACC? a. If the market price of the common stock is $43 and dividends are expected to grow at a rate of 5% per year for the foreseeable future, the company's cost of retained earnings financing is places.) %. (Round to two decimal b. If underpricing and flotation costs on new shares of common stock amount to $9 per share, the company's cost of new common stock financing is %. (Round to two decimal places.) c. If the company can issue $1.75 dividend preferred stock for a market price of $32 per share, and flotation costs would amount to $6 per share, the cost of preferred stock financing is %. (Round to two decimal places.) d. If the company can issue $1,000-par-value, 7% coupon, 14-year bonds that can be sold for $1,140 each, and flotation costs would amount to $35 per bond, using the estimation formula, the approximate after-tax cost of debt financing is %. (Round to two decimal places.) e. Using the cost of retained earnings, rr, the firm's WACC, ra, is Using the cost of new common stock, rn, the firm's WACC, ra, is %. (Round to two decimal places.) %. (Round to two decimal places.)

Explanation / Answer

a) Using DCF, cost of equity, re = D0 x (1+ g) / P + g = 1.31 x (1 + 5%) / 43 + 5% = 8.20%

b) Cost of new equity, rne = D0 x (1 + g) / (P - f) + g = 1.31 x (1 + 5%) / (43 - 9) + 5% = 9.05%

c) Cost of preferred stock, rps = Dividend / (Price - flotation) = 1.75 / (32 - 6) = 6.73%

d) Cost of debt, rd = C + (F - P)/n / (F + P)/2 = (70 + (1000 - (1140 - 35))/14) / (1000 + (1140 - 35))/2 = 5.94%

After-tax cost of debt, rdt = rd x (1 - tax) = 5.94% x (1 - 40%) = 3.56%

e) WACC = wd x rdt + wps x rps + we x re

= 0.35 x 3.56% + 0.1 x 6.73% + 0.55 x 8.20%

= 6.43%

With new stock, WACC = 6.90%

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