Lester Specialty Products currently has 350,000 shares of common stock outstandi

Question

Lester Specialty Products currently has 350,000 shares of common stock outstanding at a market price of $30 a share. Lester stock pays an annual dividend, which is expected to be $1.65 per share next year and the dividend is expected to continue to grow at the rate of 5 percent annually. Lester also has 8,500 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 5.5 percent coupon, pay interest semiannually, and mature in 7.5 years. The bonds are selling at 101 percent of face value. The company's tax rate is 32 percent. What is the firm's weighted average cost of capital?

5.8 percent

6.2 percent

7.4 percent

8.8 percent

9.4 percent

5.8 percent

6.2 percent

7.4 percent

8.8 percent

9.4 percent

Explanation / Answer

Cost of equity (ke) = 1.5 / 30 = 5%

Post tax cost of bonds (kd) = 11% x (1-0.32) = 7.48%

Weighted average cost of capital = ke x equity/ total capital + kd x bonds / total capital

= 5 x (350000 x 30) /(350000 x 30 + 8500 x 1000) + 7.48 x (8500 x 1000) / (350000 x 30 + 8500 x 1000)

= 6.2%

So, the right answer is 6.2%

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