Lang Enterprises is interested in measuring its overall cost of capital. Current
ID: 2712060 • Letter: L
Question
Lang Enterprises is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The firm is in the 40% tax bracket.
DEBT: The firm can raise debt by selling $1,000 par value, 8% coupon interest rate, 20 year bonds on which annual interest payments will be made. To sell the issue, an average discount of $30 per bond would have to be given. The firm also must pay flotation costs of $30 per bond.
PREFERRED STOCK: The firm can sell 8% preferred stok at its $95 per share par value. the cost of issuing and selling the preferred stock is expected to be $5 per share. Preferred stock can be sold under these terms.
COMMON STOCK: The firm's common stock is currently selling for $90 per share. The firm expects to pay cash dividends of $7 per share next year. The firm's dividends have been growing at an annual rate of 6% and this growth is expected to continue into the future. The stock must be underpriced by $7 per share, and flotation costs are expected to amount to $5 per share. The firm can sell new common stock under these terms.
RETAINED EARNINGS: When measuring this cost, the firm does not have concern itself with the tax racket or brokerage fees of owners. It expects to have available $100,000 of retained earnings in the coming year'; once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.
a. Calculate the after-tax cost of debt.
b. Calculate the cost of preferred stock.
c. Calculate the cosst of common stock,.
d Calculate the firm's weighted average cost of capital using he capital structure weights shown in the following table. (Round answer to the nearest 0.1%)
Source of Capital Weight
Long-Term Debt 30%
Preferred Stock 20
Common Stock Equity 50
Total 100%
Explanation / Answer
We have:
FV=1000
N=20
Pmt =1000x8% =80
PV= 1000-30-30 =940
We can use value of bond formula to compute before tax cost of debt:
After tax cost of debt Kd= r x (1-t)
= 8.64% x (1-0.40)
=5.184%
b) Cost of preferred stock:
Cost of preferred stock Kp= annual dividend/ (price – floatation cost)
= 100x 8% / (95-5)
= 8.89%
c)
Cost of common stock:
D1 = 7
G= 6%
P= 90-7 =83
F=5
Cost of common stock Ke = D1/(P-F) +g
= 7/(83-5) +0.06
=14.97%
d)
Source
weight
cost
weight x cost
Debt
0.3
5.18%
1.56%
Preferred stock
0.2
8.89%
1.78%
Common stock
0.5
14.97%
7.49%
WACC
10.82%
Source
weight
cost
weight x cost
Debt
0.3
5.18%
1.56%
Preferred stock
0.2
8.89%
1.78%
Common stock
0.5
14.97%
7.49%
WACC
10.82%
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