Please show your calculations for every problem, 6. L$M has target capital struc
ID: 2637464 • Letter: P
Question
Please show your calculations for every problem,
6. L$M has target capital structure of 50% common stock, 30% debt and 20% preferred stock. The company wishes to issue new 25 years bond with 11% coupon rate. The flotation cost will be $15 and the bond has to be sold at 5% premium. To issue new preferred stock the company has to pay $1.5 as flotation cost. The market value of preferred stock is $10 and the stock will pay $1.5 dollar dividend. New common stock will cost the company $2.5. The last dividend was $2.8 and the market value is $17. Tax rate is 40%. What is the company
Explanation / Answer
Equity = common stock = 50%
Debt = 30%
Preferred Stock = 20%
Cost of debt = Kd
time = 25 years, tax rate = 40%
let issue price = $100
Since 5% premium , therefore redemption value of bond = 105 = (1+0.05)*100
Annual interest = 11% * 105 = 11.55
flotation cost = $15 => net inflow = 100-15 = %85
Post tax coupon outflow = 11.55*(1-0.04) = $6.93
85 = 6.93/(1+Kd) + 6.93/(1+Kd?)2 + ......+ 6.93/(1+Kd?)25
Kd = 8.136%
Cost of equity = Ke = ( ((2.8*1.065)/(17-2.5)) + 6.5%) = 20.56 + 6.5 = 27.06%
Cost of preferred stock = Kp; this is not a tax deductible expense hence these will not be calculated post tax
Kp = (((1.5*1.065)/(10-1.5))+6.5)% = 18.79 + 6.5 = 25.29%
Weighetd average cost of capital = (50%*Ke) + (30%* Kd) + (20% * Kp) = (0.5*27.06) + (0.3*8.136) +(0.2*25.29) = 21.028%