The balance sheet that follows indicates the capital structure for Nealon Inc. F

Question

The balance sheet that follows indicates the capital structure for Nealon Inc. Flotation costs are (a) 15 percent of market value for a new bond issue, and (b) $2.01 per share for preferred stock. The dividends for common stock were $2.50 last year and are projected to have an annual growth rate of 6 percent. The firm is in a 34 percent tax bracket. What is the weighted average cost of capital if the firm's finances are in the following proportions? Percentage of Type of financing Future financing Bonds (8%, $1,000 par, 16-year maturity) 38% Preferred stock (5,000 shares outstanding, $50 par, $1.50 dividend) 15% Common equity 47% Total 100% a. Market prices are $1,035 for bonds, $19 for preferred stock, and $35 for common stock. There will be sufficient internal common equity funding (i.e., retained earnings) available such that the firm does not plan to issue new common stock. Calculate the firm

Explanation / Answer

Hi, Please find the answers as follows: Part A Weighted Cost of Capital with Internal Funds Cost of Debt: NP0 = 1035 (1 - .15) = 879.75 879.75 = 80/(1+kd)^t + 1000/(1+kd)^t for 16 years and t=1 kd = 9.49% After-tax cost of debt = 9.49 (1 - .34) = 6.26% Cost of Preferred Stock: = D/NP0 = 1.50/(19-2.01) = 8.83% Cost of Internal Common Funds: = D1/P0 + g = 2.5*(1+.06)/35 + .06 = 13.57% WACC = .38*6.26 + .15*8.83 + .47*13.57 = 10.08% Part B Raising External Equity Cost of External Common Stock: = D1/NP0 + g = 2.5*(1+.06)/35 - 1.21 + .06 = 14.14% WACC using external common funds= .38*6.26 + .15*8.83 + .47*14.14 = 10.35% Thanks.

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