Alpha, Inc. is expecting to issue new debt at par with a coupon rate of 6%, and

Question

Alpha, 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. Alpha 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 Alpha raises capital using a capital structure of 40% debt, 10% preferred stock and 50% common stock, what is the cost of capital for Alpha, Inc.? SHOW ALL MATH WORK!!!

Explanation / Answer

A) Cost of debt = 6 %

After tax cost of debt = 6*(1-tax rate) = 6*0.6 = 3.6 %

Cost of preffered stock = dividend/price = 2/20 = 0.1 = 10 %

Cost of Equity = r;

Price = Dividend/(r-g)

g = 0.03

r = D/P + g = 2.5/25 + 0.03 = 0.13 = 13 %

B) WACC = We*re +Wd*rd+ Wp*rp = 0.5*13 + 0.4*3.6 + 0.1*10 = 8.94 %

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