Collins Manufacturing Company has determined its optimal capital structure, whic
ID: 2721991 • Letter: C
Question
Collins Manufacturing Company has determined its optimal capital structure, which is composed of the following sources and target market value proportions: Target Market - Source of Capital Proportions Long-term debt 30% Preferred stock 10% Common stock equity 60% Debt: The firm can sell a 20-year, $1,000 par value, 9 percent bond for $980. A flotation cost of 2 percent of the face value would be required in addition to the discount of $20. Preferred Stock: The firm has determined it can issue preferred stock at $65 per share par value. The stock will pay an $8.00 annual dividend. The cost of issuing and selling the stock is $3 per share. Common Stock: The firm’s common stock is currently selling for $40 per share. The dividend expected to be paid at the end of the coming year is $5.07. Its dividend payments have been growing at a constant rate for the last five years at a rate of 8%. In order to assure that the new stock issuance will sell, it must be underpriced at $1 per share. In addition, the firm must pay $1 per share in flotation costs. The firm’s tax rate is 40 percent. Required: Calculate the firm’ weighted average cost of capital for the Collins Company assuming the firm has exhausted all retained earnings. (That is, you must consider flotation costs for the common stock issuance.)
Explanation / Answer
Details Amt $ Bond Face value 1,000 Bond Market Price 980 Less floatation cost @2% of face value 20 Net Proceeds from Market 960 Annual Interest @9% 90 Years to maturity 20.00 yrs YTM Formula= [Annual Interest+(Par Value-Market Value)/Years to Maturity]/(Par value+Market Price*2)/3 YTM =[90+(1000-960)/20]/(1000+2*960)/3 YTM =9.45% Tax Rate =40% Post Tax cost of Debt =9.45%*(1-40%)= 5.67% So post Tax cost of Debt =5.67% Preferred stock sale proceeds 65 Less Issue cost per preferred cost 3 Net Proceeds per Preferred share 62 Annual dividend per preferred share= 8 Cost of preferred share =8/62= 12.90% Cost of new equity shares Proceeds from a shares P0=40-1=39(considering underpricing) Expected dividend =D1=5.07 dividend growth rate =g=8% Floatation cost per share =F=1 Cost of new Equity= D1/(P0-F) +g =5.07/38 +0.08 =21.34% So Cost of new Equity =21.34% WACC Calculation Type of Capital % Weight Post Tax cost Weighted cost LT debt 30.00% 5.67% 1.70% Preferred stock 10.00% 12.90% 1.29% Common Equity 60.00% 21.34% 12.80% Total 15.80% So WACC of Collins Manufacturing =15.8%