Dingel Inc. is attempting to evaluate three alternative capital structures - A,B

Question

Dingel Inc. is attempting to evaluate three alternative capital structures - A,B,C. The following table shows the three structures along with relevant cost data. The firm is subject to a 40% tax rate. The risk-free rate is 5.3% and the market return is currently 10.7%

(a) Calculate the after-tax cost of debt for each capital structure

(b) Calculate the cost of preferred stock for each capital structure

(c) Calculate the cost of common stock for each capital structure

(d) Calculcate the weighted average cost of capital (WACC) for each capital structure

(e) compare the WACCs calculated in part (d) and discuss the impact of the firm's financial leverage on its WACC and its related risk

Please include detail of work

Capital Structure Item A B C Debt($ million) 35 45 55 Preferred Stock ($ million) 0 10 10 Common Stock ($ million) 65 45 35 Total Capital 100 100 100 Debt (yield to maturity) 7.0% 7.5% 8.5% Annual Preferred Stock Dividend - $2.80 $2.20 Preferred Stock (Market Price) - $30.00 $21.00 Common Stock Beta .95 1.10 1.25

Explanation / Answer

a. After tax cost of debt = Pre-tax cost of debt (1T)

A: After tax cost of debt = 0.07 (1-0.4) = 0.042

B: After tax cost of debt = 0.075 (1-0.4) = 0.045

C: After tax cost of debt = 0.085 (1-0.4) = 0.051

b. Cost of preferred stock = Dividend/Price

B: Cost of preferred stock = 2.80/30 = 0.0933

C: Cost of preferred stock = 2.20/21 = 0.1048

c. Cost of common stock = risk free rate + beta x (Market return

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