7. XYZ estimates that if it issues new common stock, the flotation cost will be

Question

7. XYZ estimates that if it issues new common stock, the flotation cost will be 15%. XYZ incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, considering the flotation cost?

% Flotation cost

15%

Net proceeds after flotation

$42.50

Cost of Newly Issued Common Stock=

8. What is XYZ’s overall, or weighted average, cost of capital (WACC)? Ignore flotation costs.

wd

30%

rd (1 – T)

6.00%

wp

10%

rp

9.00%

wc

60%

rs

14.00%

% Flotation cost

15%

Net proceeds after flotation

$42.50

Explanation / Answer

Answer:7

Cost of equity=[D0(1+g)/Net proceeds after flotation]+growth rate

=[$4.19(1.05)/$42.50]+5%

=15.35%

Answer:8

Capital structure Weight Cost of capital WACC (weight*cost of capital) Debt 30% 6% 1.800% Preferred shares 10% 9% 0.900% Common stock 60% 14% 8.400% Total 11.100%

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