Dillon Corp. has asked its financial manager to measure the cost of each specifi

Question

Dillon Corp. has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights 20% long-term debt, 20% preferred stock, and 60% common stock equity. The firm's tax rate is 30%.

Debt The firm can raise the debt by selling $1,000 par value, 9.5% coupon interest rate, 15-year bonds on which annual interest payments will be made. To sell the issue, an average discount of $30 per bond would have to be given. The firm also must pay flotation costs of $ 20 per bond.

Preferred stock The firm can sell 10% preferred stock at its $95 per share par value. The cost of issuing and selling the preferred stock is expected to be $5 per share.

Common stock The firm's common stock is currently selling for $70 per share. The firm expects to pay cash dividends of $5 per share next year. The firm's dividends have been growing at an annual rate of 5%, and this growth is expected to continue into the future. To sell new shares of common stock, the firm must underprice the stock by $6 per share,  and flotation costs are expected to amount to $5 per share.

The after-tax cost of debt for this firm is _________% (round to two decimal points).

The after-tax cost of preferred stock for this firm is ________ % (round to two decimal points).

The after-tax cost of common stock for this firm is _________ % (round to two decimal points).

The weighted cost of capital of this firm is _______% (round to two decimal points).

Explanation / Answer

a)Pretax cost of debt can be found using rate formuale in excel
=rate(nper,pmt,pv,fv,type)
=rate(15,(1000*9.5%),-950,1000,0)
=10.16%
After tax cost of debt=10.16%*(1-tax)
=10.16%*(1-30%)
=7.11%
Preferred stock dividend =10%*95=9.5
Cost of preferred stock=dividend/(par value-floation costs)
=9.5/(95-5)
=10.56%
cost of common stock can be found by dividedn discount model
Price= Dividend/(k-g)
K=(5/(70-6-5))+5%
=13.47%
WACC=(20%*10.16%)+(20%*10.56%)+(60%*13.47%)
=12.23%

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