1. What is the cost of debt for F Forecasters? The firm is in the 40% tax bracke
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Question
1. What is the cost of debt for F Forecasters? The firm is in the 40% tax bracket.
The optimal capital structure is listed below: Discuss your results.
Source of Capital
Weight
Long-Term Debt
25%
Preferred Stock
20%
Common Stock
55%
Debt:
The firm can issue $1,000 par value, 8% coupon interest bonds with a 20 year maturity date. The bond has an average discount of $30 and flotation costs of
$30 per bond. The selling price is $1,000.
Preferred Stock:
The firm can sell preferred stock with a dividend that is 8% of the current price. The stock costs $95. The cost of issuing and selling the stock is expected to be
$5 per share.
Common Stock:
The firm’s common stock is currently selling for $90 per share. The firm expects to pay cash dividends of $7 per share next year. The dividends have been growing at 6%. The stock must be discounted by $7 and flotation costs are expected to amount to $5 per share.
Retained Earnings:
The firm expects to have enough retained earnings in the coming year to be used in place of any new stock being issued.
What is the cost of Debt?
What is the cost of preferred stock for F Forecasters?
What is the cost of common stock for F Forecasters?
d. What is the cost of retained earnings for F Forecasters?
e. What is the weighted average cost of capital for F Forecasters?
f. Discuss your overall results.
Source of Capital
Weight
Long-Term Debt
25%
Preferred Stock
20%
Common Stock
55%
Explanation / Answer
Part - A
Cost of Debt (Kd) = Interest (1-tax rate)+(RV-SV/n)
__________________________
RV+SV/2
=80(1-0.40)+(1000-940/20)
_____________________
1000+940/2
=48+3/970
=5.26%
PART - B
Cost of preferred Stock (Kp) = Preferred Stock Dividend/Net proceeds issue Preferance stock
=8/95-5
=8.89%
PART - C
Cost of Equity (Ke) = D1/P0+Growth
=7/(90-5)+0.06
=0.1424 or 14.24%
PART -D
Cost of Retained Earnings is Same as cost of Equity (i.e 14.24%)
PART - E
Calculation of Weighted Average Cost of Capital
Weighted Average Cost of Capital = 10.93%
Soruce Proportion % WACC Long Term Debt 0.25 5.26% 1.32 Preferred Stock 0.20 8.89% 1.78 Common Stock 0.55 14.24% 7.83 WACC 10.93%Related Questions
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