Cost of capital Edna Recording Studios, Inc., reported earnings available to com
ID: 2788392 • Letter: C
Question
Cost of capitalEdna Recording Studios, Inc., reported earnings available to common stock of
$4,400,000
last year. From those earnings, the company paid a dividend of
$1.15
on each of its
1,000,000
common shares outstanding. The capital structure of the company includes
25%
debt,
10%
preferred stock, and
65%
common stock. It is taxed at a rate of 30%
a.If the market price of the common stock is
$38
and dividends are expected to grow at a rate of
8%
per year for the foreseeable future, the company's cost of retained earnings financing is
%.
(Round to two decimal places.
b.If underpricing and flotation costs on new shares of common stock amount to
$9
per share, what is the company's cost of new common stock
financing?
c.The company can issue
$2.25
dividend preferred stock for a market price of
$31
per share. Flotation costs would amount to
$3
per share. What is the cost of preferred stock
financing?
d.The company can issue
$1,000-par-value,
10%
coupon,
11-year
bonds that can be sold for
$1100
each. Flotation costs would amount to
$35
per bond. Use the estimation formula to figure the approximate after-tax cost of debt financing?
Explanation / Answer
a) Cost of retained earnings = Next expected dividend/Current price of the stock+ growth rate = 1.15*1.08/38 + 0.08 = 11.27% b) Cost of new common stock = Next expected dividend/(Current price-Floatation cost)+growth rate = 1.15*1.08/(38-9)+0.08 = 12.28% c) Cost of preferred stock = Dividend per share/(Current price-Floatation cost) = 2.25/(31-3) = 8.04% d) Cost of debt (using estimation formula) = [Interest*(1-t)+(maturity value-Price)/maturity period]/[(MB+Price)/2] =((100*0.70+(1000-1065)/11))/((1000+1065)/2)) = 6.21%