Problem:
Business XYZ is interested in measuring its overall cost of capital. Assuming that the business will retain the current capital structure in the future elaborated below, what is the weighted marginal cost of capital schedule? The business is within a 34% tax bracket.
Debt: The business can raise an unlimited amount of debt by selling $1,000.00 par value, 7% coupon interest rate, 15 year bonds at which annual interest payments will be made. To sell the issue, an average discount of $25 per bond would have to be given. The business must also pay a flotation cost of $25 per bond.
Preferred Stock: The business can sell 7% preferred stock at its $90 per share par value. The floatation costs are expected to be $6 per share. An unlimited amount of preferred stock can be sold under these terms.
Common Stock: The business' common stock is currently selling for $85 per share. Last year the business paid cash dividends of $5.00 per share. The business' dividends have been growing at an annual rate of 5%, and this growth is expected to continue into the future. The stock must be underpriced by $6.00 per share, and the flotation costs are expected to be $4.00 per share. The business can sell an unlimited amount of new common stock under these terms.
Retained Earnings: The firm expects to have $110,000 of retained earnings in the coming year. Once the retained earnings are exhausted, the firm will issue new common stock.
The business' capital structure weights are as follows:
Long-Term Debt 30%
Preferred Stock 30%
Common Stock 40%