Firm AAA wants to issue bonds with a 5% coupon rate, a face value of $1,000, and

Question

Firm AAA wants to issue bonds with a 5% coupon rate, a face value of $1,000, and 5 years to maturity. Firm AAA estimates that the bonds will sell for $1,080 and that flotation costs will equal $10 per bond. Firm AAA common stock currently sells for $30 per share. Firm AAA can sell additional shares by incurring flotation costs of $2.5 per share. Firm AAA paid a dividend yesterday of $4.00 per share (D0=4) and expects the dividend to grow at a constant rate of 5% per year. Firm AAA also expects to have $12 million of retained earnings available for use in capital budgeting projects during the coming year. Firm AAA 's capital structure is 30% debt and 70% common equity. Firm AAA’s marginal tax rate is 35%. a). Assuming Firm AAA 's bonds are its only debt, its after-tax cost of debt is__________. b). The cost of retained earnings is ________. c). The cost of new common stock is_________ d). Assuming firm AAA's total capital budget is $50 million, its WACC is________.

Explanation / Answer

a)cost of debt:

we can find it using rate formuale in excel

=rate(nper,pmt,pv,fv,type,guess)

nper=5 years pmt=100*5%=50

pv=1080-10=-$1070(after deducting floating cost)

fv=1000

type=0

=RATE(5,50,-1070,1000,0,)=3.45%

After tax cost of debt =(1-tax)*3.45%+.64*3.45%=2.24%

b)cost of retained earning= [D0*(1+g)/p]+g

=[4*1.05/30]+5%

=19%

c)cost of new stock=[D0*(1+g)/(p-f cost)]+g

fcost=floating cost=2.5

=[4*1.05/(30-2.5)]+5%

=20.27%

d)WACC=(cost of debt* wt of debt)+(wt of equitty*cost of equity)

=(2.24%*.3)+(20.27%*.7)

=14.86%

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