Cost of capital
a) The preferred stock of Triple-Play Corporation is currently priced at $21 per share, pays an annual dividend of 3.5% based on a par value of $100. Flotation costs associated with the sale of preferred stock equal $1.25 per share. The company’s marginal tax rate is 35%. Therefore, the cost of preferred stock would be
b) If Company offers preferred stock with a current market price of $18 per share. The preferred stock pays an annual dividend of 4% based on a par value of $100. Flotation costs for preferred stock equals $1.50 per share. The corporate tax rate is 40%. Therefore, the cost of preferred stock would be?
c) GNB Inc. is investing in a major capital budgeting project that will require funding of $16 million. The money will be raised by issuing $2 million of bonds, $4 million of preferred stock, and $10 million of new common stock. The company estimates is after-tax cost of debt to be 7%, its cost of preferred stock to be 9%, the cost of retained earnings to be 14%, and the cost of new common stock to be 17%. What is the weighted average cost of capital for this project?
d) The LMK Company is planning a $64 million expansion. The expansion is to be financed by selling $25.6 million in new debt and $38.4 million in new common stock. The before-tax required rate of return on debt is 9 percent and the required rate of return on equity is 14 percent. If the company is in the 35 percent tax bracket, what is the firm’s cost of capital?
e) Given the following capital structure, compute the company’s weighted average cost of capital.
Type of Capital Percent of Capital Structure Before-Tax Component Cost
Bonds 40% 7.5%
Preferred Stock 5% 11%
Common Stock (Internal Only) 55% 15%
Solve for the company’s marginal tax rate is 40%.
f) Painter Pro has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of common equity, based upon current market values. The firm’s yield to maturity on its bonds is 7.4%, and investors require an 8% return on the firm’s preferred and a 14% return on common stock. If the tax rate is 35%, calculate the WACC
g) Princeton Technology has the following capital structure.
Debt 40%
Common equity 60
The after-tax cost of debt is 6 percent; and the cost of common equity is 13 percent.
What is the firm’s weighted average cost of capital?
An outside consultant has suggested that because debt is cheaper than equity, the firm should switch to a capital structure that is 50 percent debt and 50 percent equity. Under this new and more debt-oriented arrangement, the aftertax cost of debt is 7 percent, and the cost of common equity (in the form of retained earnings) is 15 percent. Recalculate the firm’s weighted average cost of capital.
Which plan is optimal in terms of minimizing the weighted average cost of capital?
