A firm has determined its optimal capital structure, which is composed of the following sources and target market value proportions.
Table 1:
Source of capital: long term debt Target Market Proportions: 20% Source of capital: preferred stock Target Market Proportions: 10 Source of capital: common stock equity Target Market Proportions: 70
Debt: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40.
Preferred Stock: The firm has preferred stock selling at $72 per share par value. The stock pays a $10 annual dividend.
Existing Common Stock: A firm’s common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74 and the dividend rate has grown at 5% per year and should continue to do so for the forseeable future.
New common stock if issued must be underpriced $1 per share in floatation costs.
Additionally, the firm’s marginal tax rate is 40 percent.
Questions are:
1) What is the firm’s before-tax cost of debt? (See Table 1)
2) What is the firm’s after-tax cost of debt? (See Table 1)
3) What is the firm’s cost of preferred stock? (See Table 1)
4) What is the firm’s cost of a new issue of common stock?
5) The firm’s cost of retained earning is?
6) The weighted average cost of capital up to the point when retained earnings are exhausted is?
7) If the target market proportion of long term debt is reduced to 15 percent- increasing the proportion of common stock equity to 75 percent, what will be the revised weighted average cost of capital?
4) What is the weighted
average cost of capital?
