Q u e s t i o n A . C a l c u l a t e t h e i n d i v i d u a l c o s t o f e a c h s o u r c e o f f i n a n c i n g . ( R o u n d t o o n e d e c i m a l p l a c e . ) F o r q u e s t i o n 1 , f o l l o w t h e f o r m u l a a t t a c h e d i n t h e p i c t u r e s . B . C a l c u l a t e t h e f i r m ’ s w e i g h t e d a v e r a g e c o s t o f c a p i t a l u s i n g t h e w e i g h t s s h o w n i n t h e f o l l o w i n g t a b l e , w h i c h a r e b a s e d o n t h e f i r m ’ s t a r g e t c a p i t a l s t r u c t u r e p r o p o r t i o n s . ( R o u n d t o o n e d e c i m a l p l a c e . ) S o u r c e o f c a p i t a l W e i g h t L o n g - t e r m d e b t 4 0 % P r e f e r r e d s t o c k 1 5 C o m m o n s t o c k e q u i t y 4 5 T o t a l 1 0 0 %
1 . H u m b l e M a n u f a c t u r i n g i s i n t e r e s t e d i n m e a s u r i n g i t s o v e r a l l c o s t o f c a p i t a l . T h e f i r m i s i n t h e 4 0 % t a x b r a c k e t . Cu r r e n t i n v e s t i g a t i o n h a s g a t h e r e d t h e f o l l o w i n g d a t a :
D e b t . T h e f i r m c a n r a i s e d e b t b y s e l l i n g $ 1 , 0 0 0 - p a r - v a l u e , 1 0 % c o u p o n i n t e r e s t r a t e , 1 0 - y e a r b o n d s o n w h i c h a n n u a l i n t e r e s t p a y m e n t s w i l l b e m a d e . T o s e l l t h e i s s u e , a n a v e r a g e d i s c o u n t o f $ 3 0 p e r b o n d m u s t b e g i v e n . T h e f i r m m u s t a l s o p a y f l o t a t i o n c o s t s o f $ 2 0 p e r b o n d .
P r e f e r r e d s t o c k . T h e f i r m c a n s e l l 1 1 % ( a n n u a l d i v i d e n d ) p r e f er r e d s t o c k a t i t s $ 1 0 0 - p e r - s h a r e p a r v a l u e . T h e c o s t o f i s s u i n g a n d s e l l i n g t h e p r e f e r r e d s t o c k i s e x p e c t e d t o b e $ 4 p e r s h a r e .
C o m m o n s t o c k . T h e f i r m ’ s c o m m o n s t o c k i s c u r r e n t l y s e l l i n g f o r $ 8 0 p e r s h a r e . T h e f i r m e x p e c t s t o p a y c a s h d i v i d e n d s o f $ 6 p e r s h a r e n e x t y e a r . T h e f i r m ’ s d i v i d e n d s h a v e b e e n g r o w i n g a t a n a n n u a l r a t e o f 6 % , a n d t h i s r a t e i s e x p e c t e d t o c o n t i n u e i n t h e f u t u r e . T h e s t o c k w i l l h a v e to b e u n d e r p r i c e d b y $ 4 p e r s h a r e , a n d f l o t a t i o n c o s t s a r e e x p e c t e d t o a m o u n t t o $ 4 p e r s h a r e .
R e t a i n e d e a r n i n g s . T h e f i r m e x p e c t s t o h a v e $ 2 2 5 , 0 0 0 o f r e t a i ne d e a r n i n g s a v a i l a b l e i n t h e c o m i n g y e a r . O n c e t h e s e r e t a i n e d e a r n i n g s a r e e x h a u s t e d , t h e f i r m w i l l u s e n e w c o m m o n s t o ck a s t h e f o r m o f c o m m o n s t oc k e q u i t y f i n a n c in g .
Q u e s t i o n
A . C a l c u l a t e t h e i n d i v i d u a l c o s t o f e a c h s o u r c e o f f i n a n c i n g . ( R o u n d t o o n e d e c i m a l p l a c e . )
F o r q u e s t i o n 1 , f o l l o w t h e f o r m u l a a t t a c h e d i n t h e p i c t u r e s .
B . C a l c u l a t e t h e f i r m ’ s w e i g h t e d a v e r a g e c o s t o f c a p i t a l u s i n g t h e w e i g h t s s h o w n i n t h e f o l l o w i n g t a b l e , w h i c h a r e b a s e d o n t h e f i r m ’ s t a r g e t c a p i t a l s t r u c t u r e p r o p o r t i o n s . ( R o u n d t o o n e d e c i m a l p l a c e . )
S o u r c e o f c a p i t a l W e i g h t
L o n g - t e r m d e b t 4 0 %
P r e f e r r e d s t o c k 1 5
C o m m o n s t o c k e q u i t y 4 5
T o t a l 1 0 0 %
![FORMULAS:
Cost of Long-Term Debt
where
where
Cost of Preferred Stock
Cost of Common Stock Using the Constant-Growth Valuation (Gordon) Model
$1,000 - N
11
N₂ + $1,000
2
where
I-annual interest in dollars
N-net proceeds from the sale of debt (bond)
- number of years to the bond's maturity
rs= (D₁/ Po) + g
Cost of Common Stock Using the Capital Asset Pricing Model (CAPM)
1₁ = Ry + [b × (rm - R₂)]
where
Po value of common stock
D₁-per-share dividend expected at the end of year 1
r = required return on common stock
g=constant rate of growth in dividends
R, - risk-free rate of return
T-market return; return on the market portfolio of assets
Cost of New Issues of Common Stock
In = (D₁/ Nn) + g
Calculating Weighted Average Cost of Capital (WACC)
r₂ = (w, x r.) + (wp X Tp) + (W₂ X Form)
w, proportion of long-term debt in capital structure
w = proportion of preferred stock in capital structure
w, = proportion of common stock equity in capital structure
w+w+w, 1.0](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fec91a0c8-e3f7-48f0-835f-f62fbe6d1324%2F6d671ebe-2dd3-41ce-9a76-76b9b632fd1e%2Fz8x0q2v_processed.jpeg&w=3840&q=75)
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