Grand, Inc. is expecting to issue new debt at par with a coupon rate of 6%, and
ID: 2669343 • Letter: G
Question
Grand, Inc. is expecting to issue new debt at par with a coupon rate of 6%, and to issue new preferred stock with a $2.00 per share dividend at $20 a share. Common stock is currently selling for $25 a share. Grand expects to pay a dividend of $2.50 per share next year, and a market analysis indicates dividends will grow at a rate of 3% per year. The marginal tax rate is 40%.A) What is the cost of debt, cost of preferred stock and cost of common stock?
B) If Grand raises capital using a capital structure of 40% debt, 10% preferred stock and 50% common stock, what is the cost of capital for Grand, Inc.?
Explanation / Answer
A) For common stock: P0=$25, D1=$2.50, g=3% We know from DCF, P0=D1/(Ks-g) or Ks = g + D1/P0 = 3%+2.50/25 = 13.00% So COst of COmmon equity is 13% After Tax Cost of Debt = (1-T)* = (1-40%)*6% = 3.60% Cost of Pref stock Kp = Pref Div/Pref share price = $2/$20 = 10% B) WACC = Wd*Kd(1-T) + Ws*Ks + Wp*Kp ie WACC = 40%*(1-40%)*6% + 50%*13% + 10%*10% = 8.94% So Cost of capital for Grant is 8.94%
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