***Please show all of your work when answering the question, thank you!*** Jury
ID: 2671761 • Letter: #
Question
***Please show all of your work when answering the question, thank you!***
Jury Company wants to calculate the component costs in its capital structure. Common stock currently sells for $33, and is expected to pay a dividend of $.40. Jury's dividend growth rate is 8%, and flotation cost is $1.25. Preferred stock sells for $40, pays a dividend of $3.00, and carries a flotation cost of $1.10. Jury Company bonds yield 7% in the market. Jury is in the 30% tax bracket.
A) Calculate cost of debt, cost of new common stock, cost of preferred stock and cost of retained earnings.
B) Calculate the company's weighted average cost of capital assuming that its new financing will consist of 40% debt, 10% preferred stock, and 50% retained earnings.
***Please show all of your work when answeing the question, thank you!***
Explanation / Answer
A) Calculation of cost of debt: Cost of debt is = Bond yield*(1-tax rate) From the given data, Bond yield is 7% and tax rate is 35%. by substituting these values in the cost of debt formula: Cost of debt = 7%*(1-35%) = 7%*(0.65) = 4.55%. Cost of debt is 4.55%. Calculation of cost of common stock: From Gordon dividend growth model, Cost of common stock = (Expected dividend/Currnet market price - Floation costs)+ growth rate = ($0.40/$33-$1.25)+8% = 0.0126+0.08 = 0.0926 (or) 9.26% Cost of common stock is 9.26%. Calculation of cost of preferred stock: Formula for cost of preferred stock = Preferred dividend/(Current price of preferred stock-floation costs) = $3.00/($40-$1.1) = $3.00/38.9 = 0.077 (or) 7.71% Cost of preferred stock is 7.71%. B. Calculation of Weighted Average Cost of Capital: Weighted Average Cost of Capital = Cost of debt*% of debt + Cost of preferred stock*% of preferred stock+ Cost of common stock*% of common stock. WACC = 4.55%*0.4+7.71%*0.1+9.26%*0.5 = 1.82%+0.771%+4.63% = 7.221% WACC is 7.221%. Formula for cost of preferred stock = Preferred dividend/(Current price of preferred stock-floation costs) = $3.00/($40-$1.1) = $3.00/38.9 = 0.077 (or) 7.71% Cost of preferred stock is 7.71%. B. Calculation of Weighted Average Cost of Capital: Weighted Average Cost of Capital = Cost of debt*% of debt + Cost of preferred stock*% of preferred stock+ Cost of common stock*% of common stock. WACC = 4.55%*0.4+7.71%*0.1+9.26%*0.5 = 1.82%+0.771%+4.63% = 7.221% WACC is 7.221%.Related Questions
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