Afirm has determined its optimal capital structure which is composed of the foll

Question

Afirm has determined its optimal capital structure which is composed of the following sources and target market value proportions. The firm can sell a 15-year, $1,000 per value, 8 percent semi-annual bond for $960. A notation cost of 2 percent o| the face value would also be required , but was not factored into the market price listed above. The firm has determined it can issue preferred stock at $25 per share par value. I he stock will pay a $2.25 annual dividend. The cost of issuing and selling the stock is $2 per share. A firm's common stock is currently selling for S34 per share. The dividend expected to be paid at the end of this year is $2.74. Its dividend payments have been growing at a constant rate of 4% for the last four years. It is expected any new common stock issue would be subject to $1 per share in floatation costs. Additionally, the firm's marginal tax rate is 35 percent. The firm is considering a project with the following cash flows: initial cost year 1 year 2 year 3 $5,000,000 $1.000.000 $2,000,000 $3,300,000 The firm's cost of a new issue of common stock is . (See Table 1.) What is the firm's WACC if all new components had to be issued? (See Table 1.)

Explanation / Answer

Cost of Equity = (Expected dividend next year / Current Price) + g

= [2.74/(34-1) ]+ 0.04

= 12.30%

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