HBM, Inc. has the following capital structure: Assets $400,000 Debt $140,000 Pre

ID: 2433870 • Letter: H

Question

HBM, Inc. has the following capital structure:
Assets $400,000
Debt $140,000
Preferred stock 20,000
Common stock 240,000

The common stock is currently selling for $15 a share, pays a cashdividend of $0.75 per
share, and is growing annually at 6 percent. The preferred stockpays a $9 cash dividend and
currently sells for $91 a share. The debt pays interest of 8.5percent annually, and the firm
is in the 30 percent marginal tax bracket.

a. What is the after-tax cost of debt?
b. What is the cost of preferred stock?
c. What is the cost of common stock?
d. What is the firm's weighted-average cost of capital?

Explanation / Answer

Total Assets = Total Debt + Total Preferred Stock +Total Common Stock

Debt= $140,000

Preferred Stock = 20,000

Common Stock = 240,000

Cost of debt before tax = 8.5%

Tax rate = 30%

Capital Structure

Stock Value

Stock Weights

Debt

$140,000

[$140,000 / $400,000] = 0.35

Preferred Stock

$20,000

[$20,000 / $400,000] = 0.05

Common Stock

$240,000

$240,000 / $400,000] = 0.60

Total Capital

$400,000

(a) Calculation Company’s after-tax costof debt:

After-tax cost of debt = before-tax rate * (1- marginal taxrate)

= 8.5% * (1-30%)

= 0.085 * 0.7

= 0.0595 (or) 5.95%

After-tax cost of debt (RD) =5.95%

(b) Calculating Cost of Preferred Stock(RP):

Preferred Stock Dividend = $9

Preferred Stock Value = $91

Cost of Preferred Stock = [$9 / $91]

Cost of Preferred Stock = 0.0989 (or)9.89%

(c) Calculation of Cost of Common stock(RE):

(Using DividendGrowth Model)

Stock Value (P0) = D0 (1+g) / (R –g)

Stock Value (P0) = D1 / (R – g)

Cost of Common Stock (R) = [D1 / P0] +g

Cost of Common Stock = ($0.75 / 15) + 0.06

= 0.05 + 0.06

= 0.11 (or) 11%

Cost of Common Stock = 11%

Calculation of weighted average cost of capital(WACC):

WACC = (E/V) * RE + (P/V) * RP +(D/V) * RD

= (0.6 * 11%) + (0.05 * 9.89%) + (0.35 * 5.95%)

= (0.6 * 0.11) + (0.05 * 0.0989) + (0.35 * 0.0595)

= 0.066 + 0.004945 + 0.020825

= 0.09177 (or) 9.18%

Weighted Average Cost of Capital (WACC) =9.18%