a. Compute the cost of capital for the individual components in the capital structure. Note: Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places. Debt Preferred stock Common equity Weighted Cost % % %
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
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![Problem 11-24 (Algo) Changes in costs and weighted average cost of capital [LO11-1]
Brook's Window Shields Incorporated is trying to calculate its cost of capital for use in a capital budgeting decision. Mr. Glass, the vice
president of finance, has given you the following information and has asked you to compute the weighted average cost of capital.
The company currently has outstanding a bond with a 9.2 percent coupon rate and another bond with a 6.5 percent coupon rate. The
firm has been informed by its investment banker that bonds of equal risk and credit rating are now selling to yield 10.4 percent.
The common stock has a price of $52 and an expected dividend (D₁) of $4.70 per share. The firm's historical growth rate of earnings
and dividends per share has been 6.5 percent, but security analysts on Wall Street expect this growth to slow to 4 percent in future
years.
The preferred stock is selling at $48 per share and carries a dividend of $3.75 per share. The corporate tax rate is 35 percent. The
flotation cost is 2.6 percent of the selling price for preferred stock. The optimum capital structure is 25 percent debt, 15 percent
preferred stock, and 60 percent common equity in the form of retained earnings.
a. Compute the cost of capital for the individual components in the capital structure.
Note: Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.
Weighted Cost
Debt
Preferred stock
Common equity
%
%
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