The company has the following capital structure: Debt $36,000,000 Preferred stoc
ID: 2658068 • Letter: T
Question
The company has the following capital structure: Debt $36,000,000 Preferred stock $18,000,000 Common stock $66,000,000 To support the new investment, the company needs to raise $40,000,000. What will be the cost of capital if the company decide to raise the needed capital proportionally and with following costs? Please use the following information to calculate the weighted cost of capital:
a. Bond – A 30-year bond with a face value of $1000 and coupon interest rate of 13% and floatation cost of $20 (Tax is 35%)
b. Preferred stock Face value of $35 that pays dividend $5 and floatation cost of $2
c. Common stock Market value of $54 with floatation cost of $3.5. Last dividend was $6. The dividend will expect to grow at 7%. Please show work
Explanation / Answer
Cost of Debt with floatation cost will be calculated as follows =
Cost of Debt = Coupon ( 1 - tax rate)/(Face value - floatation cost)
= 84.50 / 980 = 8.62% per annum
Cost of preferred stock will be calculated using following formula -
Cost of preferred stock = Dividend / (price - floatation cost)
= 5/(35 - 2) = 5 / 33 = 15.15% per annum
Cost of Equity with growth will be calculated as per following formula -
Cost of Equity = Dividend to be paid next year/ (Price - Floatation cost) + growth rate
Dividend to be paid next year = 6 x (1.07) = $ 6.42
Cost of Equity = 6.42 / (54 - 3.5) + 7% = 12.71% + 7% = 19.71% per annum
Total Capital = Debt + Preferred Stock + Common Stock = 36 Mn +18 Mn + 66 Mn = 120 Mn
WACC = 8.62 x 36 / 120 + 15.15 x 18 / 120 + 19.71 x 66 / 120 = 15.70% per annum
Therefore, the weighted average cost of capital comes to 15.70% p.a