You have been able to make smart business decisions and now own a company of you
ID: 2766661 • Letter: Y
Question
You have been able to make smart business decisions and now own a company of your own!!! Your new company has the following information available to you as you make capital budgeting decisions.
Source of capital Target market proportions
Long term debt 20%
Preferred stock 10%
Common stock equity 70%
DEBT – The firm can sell a 12 year, $1,000 par value, 7% (coupon interest rate) bond for $960
A flotation cost of 2% of the face value would be required in addition to the discount (in price) of $40 ($1,000-$960)
PREFERRED STOCK – Can be issued at $75 per share par value. It will pay an annual dividend of $10. Cost of issuing & selling this stock would be $3 per share
COMMON STOCK – Currently selling for $18 per share. Dividend expected to be paid at the end of the coming year is $1.74. Dividends have been growing at a constant rate for 4 years and 4 years ago, the dividend was $1.50. In selling this stock – flotation costs would amount to $1per share from the current selling price. Your company’s tax rate is 40%
Your cost for issuing new common stock is?
Your cost of preferred stock is?
Your WACC presuming you will have to issue new shares of common stock?
Explanation / Answer
Cost of Issuing New stock would be equal to the cost of equity to the company
Now if you isuue shares now , you would get $17 per share as $1 is folation cost per share
Cost of Equity = D1/ P +g
D1 is the dividend in next year which is given as 1.74
For Calculating growth rate g we will ahve = 1.5*(1+g)^5 =1.74
g= 3.01%
Hence Cost of issuing new shares = 1.74/17 + .031 =10.23% +3.01%= 13.25%
Rate is return on preferd stock would be given by = d1/p
= dividend in next year
p= price of prefernce share incluniding preference shares =$75-$3= $72
= 10/72 =13.88%
Cost of debt
It would be the yield to maturity of the bond including the face value
= Now considering 2% discount = $ 2 would be floation cost per 1000
Total price of the bond would be =$960-$2 = $958
n=12
PMT =70
Rate ?
RATE(12,-70,958,-1000,0,0) =7.54%
Cost fo debt = YTM*(1-t) =4.52%
Nowe will calculat the weighted average yield to calculat ethe WACC
Debt 4.52% 20% Preferd stock 13.88% 10% Equity 13.25% 70% WACC 11.57%Related Questions
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