Lancaster Engineering Inc (LEI) has the following capital structure, which it considers to be optimal.
Long Term Debt 30%
Preferred Stock 10%
Common Stock 60%
Total 100%
- LEI can obtain capital in the following ways:
- New Preferred Stock with a dividend of $12 can be sold at $97 to the public; however LEI will incur $2 of flotation costs for each share it sells.
- Debt can be sold at a pre-tax cost of 12%.LEI's tax rate is 40%.(Note that 12% is the pre-tax cost; all costs must be expressed on an after-tax basis so as to be comparable.)
- LEI can sell its common stock for $55.However they expect underwriting fees to be $3 per share and an additional $2 per share in other flotation costs.They expect to pay a dividend on the common stock next year of $3.50 and it is expected that dividends will continue to grow at the historical rate of 8%.
Required:
1. Determine the cost of each capital component.
2. Determine the weighted average cost of capital (WACC) for LEI.