Cost of capital Edna Recording Studios, Inc., reported earnings available to com
ID: 2795497 • Letter: C
Question
Cost of capital Edna Recording Studios, Inc., reported earnings available to common stock of S4,600,000 last year. From those earnings, the company paid a dividend of S1.16 on each of its 1,000,000 common shares outstanding The capital structure of the company includes 30% debt 20% preferred stock, and 50% common stock. It is taxed at a rate of 35%. a f the market price of the common stock s S35 and di dends are expected to grow at a rate of 9% per ear for the foreseeable uture what is he compar s cost of er med enn sina ? b· lf underpricing and flotation costs on new shares of common stock amount to $7 per share, what is the company's cost of new common stock financing? c. The company can issue $2.37 dividend preferred stock for a market price of $27 per share. Flotation costs would amount to $2 per share. What is the cost of preferred stock financing? d. The company can issue $1,000-par value, 8% coupon. 9-year bonds that can be sold for S 1.230 each. Flotation costs would amount to $40 per bond. Use the estimation formula to gure the approximate after ex co sto debt financing? e. What is the WACC? Round wo de ma a. the market price o the common stock s S35 and di dends are expected to grow at a rate o 9% per year or the reseeable future the corn any's cost o retained a mings financ s b lf underpricing and otation costs on new shares of common stock amount to S7 per share, the company's cost of new common stock inancing s % Round to vo de ma aces. c f the company can issue $2.37 dividend preferred stock for a market price of S27 per share, and otation costs would amount to S2 per share, the cost of preferred stock financing s % d. If the company can issue $1,000-par value. 8% coupon 9-year bonds that can be soldfors.230 each, and ation costs would am urt to pe bon usin hees mation o ulah e. Using the cost of retained earnings, the firm's WACC·g. is | % (Round to two decimal places ) Using the cost of new common stock, r, the firm's WACC, % (Round to two decimal places ) Round to two decima paces pprox mate after ax costof in gis %Explanation / Answer
a) Cost of retained earnings, re = D0 x (1 + g) / P + g = 1.16 x (1 + 9%) / 35 + 9% = 12.61%
b) Cost of new equity, rn = D0 x (1 + g) / (P - F) + g = 1.16 x (1 + 9%) / (35 - 7) + 9% = 13.52%
c) Cost of preferred stock, rps = D / (P - F) = 2.37 / (27 - 2) = 9.48%
d) Cost of debt can be calculated using I/Y function on a calculator
N = 9, PMT = 8% x 1000 = 80, PV = - 1230 + 40 = -1190, FV = 1000 => Compute I/Y = rd = 5.29%
e) WACC = wd x rd x (1 - tax) + wps x rps + we x re
= 30% x 5.29% x (1 - 35%) + 20% x 9.48% + 50% x 12.61%
= 9.23%
WACC = wd x rd x (1 - tax) + wps x rps + we x rn
= 30% x 5.29% x (1 - 35%) + 20% x 9.48% + 50% x 13.52%
= 9.69%