If Bad Boys, Inc. raises capital using 30% debt, 5% preferred stock, and 65% com
ID: 2791292 • Letter: I
Question
If Bad Boys, Inc. raises capital using 30% debt, 5% preferred stock, and 65% common stock, what is Bad Boys cost of capital?
The previous question was:
Bad Boys, Inc. is evaluating its cost of capital. Under consultation, Bad Boys, Inc. expects to issue new debt at par with a coupon rate of 8% and to issue new preferred stock with a $2.50 per share dividend at $25 a share. The common stock of Bad Boys, Inc. is currently selling for $20.00 a share. Bad Boys, Inc. expects to pay a dividend of $1.50 per share next year. An equity analyst foresees a growth in dividends at a rate of 5% per year. Bad Boys, Inc. marginal tax rate is 35%. If Bad Boys, Inc. raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is Bad Boys cost of capital? Answer 9.09%
Explanation / Answer
Cost of debt = 8%
Cost of preferred stock = 2.5/25 = 10%
Cost of Equity:
20 = 1.5/ (Cost of Equity - 5%)
Cost of Equity = 12.5%
Weight of debt = 30%
Weight of Preferred Stock = 5%
Weight of Common Stock = 65%
Tax = 35%
Cost of Capital = 0.3 * 8% * 0.65 + 0.05 * 10% + 0.65 * 12.5%
Cost of Capital = 10.185%