Can you please help me with this question? Thank you Calculation of individual c
ID: 2735102 • Letter: C
Question
Can you please help me with this question? Thank you
Calculation of individual costs and WACC Dillon Labs has asked its financial manager
to measure the cost of each specific type of capital as well as the weighted average
cost of capital. The weighted average cost is to be measured by using the following
weights: 40% long-term debt, 10% preferred stock, and 50% common stock equity
(retained earnings, new common stock, or both). The firm’s tax rate is 40%.
Debt The firm can sell for $980 a 10-year, $1,000-par-value bond paying annual
interest at a 10% coupon rate. A flotation cost of 3% of the par value is required
in addition to the discount of $20 per bond.
Preferred stock Eight percent (annual dividend) preferred stock having a par
value of $100 can be sold for $65. An additional fee of $2 per share must be paid
to the underwriters.
Common stock The firm’s common stock is currently selling for $50 per share.
The dividend expected to be paid at the end of the coming year (2016) is $4. Its
dividend payments, which have been approximately 60% of earnings per share in
each of the past 5 years, were as shown in the following table.
Year Dividend
2015 $3.75
2014 3.50
2013 3.30
2012 3.15
2011 2.85
Explanation / Answer
a. After-tax cost of debt
Approximate approach
rd = I+($1,000-Nd)/(Nd+$1,000)/2
Rd =[ 100+(1,000-980)/10]/($980+1,000)/2 = (100+2)/990 = 10.30%
Ri = 1030*(1-.40) = 6.18%
Calculator approach
N = 10, PV =$980, PMT=-$100, FV=- $1,000
sOLVE FOR I =10.33%
After-tax cost of debt = 10.33(1-.040) = 6.20%
b. Cost of preferred stock
Rp= Dp/Np =$8/63 = 12.70%
c. Cost of new common stock equity:Solve for g:
Rs = (d1/P0)+g = 4/50+7.10% = 15.10%(approx.)
New common stock:
Rn = D1/Nn+g = 4/(45-*3)+7.10%= 16.62%
WACC = ra = wiri + wprp + wsrr or n
WACC = .40(10.77%) + .10(12.70%) + .50(15.10%)
11.35%