Chapter 10, Problem 18P

a.

Summary Introduction

To determine: The cost of each of the capital components.

Introduction:

Cost of Capital:

In any company there is a need of fund for various purposes. The companies raise capital through various sources such as equity, debt, and preferred stock. The cost of capital is the total cost of raising capital. It consists of cost of debt, cost of equity, and cost of the preferred stock.

After-Tax Cost of Debt:

It can be defined as relevant cost of new debt considering tax deductibility in interest. It is the cost of debt after tax savings.  The interest on the debt is tax deductible. The tax can be saved on the interest paid on the debt. It is used to calculate the weighted average cost of capital.

Cost of Preferred Stock:

The return earned by the firm’s preferred stockholders from the investment in preferred stock is a cost of the preferred stock. It is computed by dividing the dividend received on preferred stock by the current price of the preferred stock.

Cost of Equity:

It is the cost of the company while raising finance by issuing equity. It is the earnings from the investment to the firm’s equity investors. It is the return to the stockholders’  equity investments. The issue of new stock incurs the flotation cost.

b.

Summary Introduction

To determine: WACC of A Corporation.

Introduction:

Weighted Average Cost of Capital:

It is the weighted average cost of capital of all the sources through which a firm finances its capital. It is the rate that a company will pay to all for raising finance. It can be termed as firm’s cost of capital. The company raises money through various sources such as common stock and preference share debt. The WACC is computed by taking the relative weight of each item of capital structure.

c.

Summary Introduction

To identify: The projects that should be accepted by A Corporation. If only the project with expected returns more than WACC should be accepted.