Company XYZ paid a dividend yesterday of $3 per share (D0=$3) The dividend is ex

Question

Company XYZ paid a dividend yesterday of $3 per share (D0=$3) The dividend is expected to grow at a constant rate of 10%/year. The price of XYZ stock today is $25/share. If XYZ decides to issue new common stock, flotation costs will equal $2.50/share. XYZ marginal tax rate is 35%.

a. based on above, what are the costs of new common stock? (retained earnings)

b. the firm decided to finance a new capital of 10 million at the debt to equity ratio as 7:3. The firm issues a 10-year, 6% coupon bond at its par value. The floatation cost is $50. Calculate the corresponding cost of capital (assume the equity financing all comes from new issues)

Explanation / Answer

a) Cost of new stock, ke = D0 x (1 + g) / (P - F) + g = 3 x 1.10 / (25 - 2.5) + 10% = 24.7%

b) Weight of debt, wd = D/E / (1 + D/E) = 7/3 / (7/3 + 1) = 70%,

weight of equity, we = 1 - 70% = 30%

Cost of debt can be calculated using I/Y function

N = 10, PMT = 6% x 1000 = 60, PV = -(1000 - 50) = -950, FV = 1000 => Compute I/Y = 6.70%

Cost of capital = wd x kd x (1 - tax) + we x ke = 70% x 6.70% x (1 - 35%) + 30% x 24.7% = 10.45%

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.