ABC, Inc. is looking at raising additional capital for a future project. For ABC

Question

ABC, Inc. is looking at raising additional capital for a future project. For ABC, Inc. to determine whether this project is worth investing in, it must first determine the cost of the capital it will use to finance the project. Demonstrate each step for credit.

A. The firm’s current stock price is $50 and it has 3 million shares of stock outstanding. The firm also has $35 million of preferred stock and $60 million of debt. Calculate the weights of each capital component.

B. The firm is looking at issuing a new 30-year bond that pays a semi-annual coupon of 8%. The bond is expected to sell at $870. The firm’s tax rate is 35%. Calculate the After-Tax rd.

C. The firm just paid out a dividend of $3.50 on common stock with an expected growth rate of 3%. Calculate the re.

D. The firm expects its preferred stocks to sell for $120.00. The firm pays a $6 annual dividend on its preferred stock. Calculate the rps.

E. What is the firm’s WACC?

Explanation / Answer

A) Market value ($ million) Weight Common stock (3m*$50) 150 61.22% Preferred stock 35 14.29% Debt 60 24.49% Total 245 100.00% B) The before tax cost of debt = YTM of the bond. YTM (using a financial calculator) = 9.29% After tax cost of debt [rd] = 9.29*(1-0.35) = 6.04% Answer C) Cost of equity [re] using 'constant dividend growth formula' = D1/P0 +g, where D1 = next expected dividend, P0=Current price and g=growth rate. Substituting values we have Cost of equity [re] = 3.5*1.03/50 + 0.03 = 10.21% Answer D) Cost of preferred stock [rps] = Dividend/Price = 6/120 = 5.00% Answer E) WACC: Cost [%] Weight WACC [%] Common stock (3m*$50) 10.21 61.22% 6.25 Preferred stock 5.00 14.29% 0.71 Debt 6.04 24.49% 1.48 Total 8.44% Answer

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