Problems for Chapter 9 Meacham Corp. wants to issue bonds with a 9% coupon rate,

Question

Problems for Chapter 9 Meacham Corp. wants to issue bonds with a 9% coupon rate, a face value of $1,000, and 12 years to maturity. The coupon is paid semi-annually. Meacham estimates that the bonds will sell for $1,090 and that flotation costs will equal $15 per bond. Meacham Corp. common stock currently sells for $30 per share. Meacham can sell additional shares by incurring flotation costs of $3 per share. Meacham paid a dividend yesterday of $4.00 per share and expects the dividend to grow at a constant rate of 5% per year. capital budgeting projects during the coming year. Meacham's capital structure is 40% debt and 60% common equity. Meacham's marginal tax rate is 35%. 1) Calculate the after-tax cost of debt assuming Meacham's bonds are its only debt. 2) Calculate the cost of retained eanings. 3) Calculate the cost of new common stock. 4) Calculate the weighted average cost of capital assuming Meacham's total capital budget is $30 million.

Explanation / Answer

a) Before-tax Cost of debt can be calculated using I/y function

N = 12 x 2 = 24, PMT = 9% x 1000/2 = 45, PV = -1090 + 15 = -1075, FV = 1000

=> Compute I/Y = 4.01% (semi-annual)

Cost of debt, kd = 2 x 4.01% = 8.02%

After-tax cost of debt = kd x (1 - tax) = 8.02% x (1 - 35%) = 5.21%

b) Cost of retained earnings, ke = D0 x (1 + g) / P + g = 4 x (1 + 5%) / 30 + 5% = 19%

c) Cost of new equity, kne = D0 x (1 + g) / (P - F) + g = 4 x 1.05 / (30 - 3) + 5% = 20.56%

d) Total Capital = 30 million

Debt = 40% x 30 = 12 million, Equity = 60% x 30 = 18 million, of which 12 million from retained earnings and 6 million from new equity

WACC = wd x kd x (1 - tax) + wne x kne + we x ke

= 40% x 5.21% + 12 / 30 x 19% + 6 / 30 x 20.56%

= 13.80%

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