Dingel Inc. is attempting to evaluate three alternative capital structures- A, B, and C. The following table shows the three structures along with relevant cost data. The firm is subject to a 40 percent marginal tax rate. The risk-free rate is 5.3 percent and the market return is currently 10.7 percent.
|
|
Capital Structure
|
|
Item
|
A
|
B
|
C
|
|
Debt ($ million)
|
35
|
45
|
55
|
|
Preferred Stock ($ million)
|
0
|
10
|
10
|
|
Common Stock ($ million)
|
65
|
45
|
35
|
|
Total Capital ($ million)
|
100
|
100
|
100
|
|
Debt (yield-to-maturity)
|
7.0%
|
7.5%
|
8.5%
|
|
Annual Preferred Stock Dividend
|
-
|
$ 2.80
|
$ 2.20
|
|
Preferred Stock (Market Price)
|
-
|
$ 30.00
|
$ 21.00
|
|
Common Stock Beta
|
0.95
|
1.10
|
1.25
|
a. Calculate the after-tax cost of debt for each capital structure.
b. Calculate the cost of preferred stock for each capital structure.
c. Calculate the cost of common stock for each capital structure.
d. Calculate the weighted average cost of capital (WACC) for each capital structure.
e. Compare the WACCs calculated in part (d) and discuss the impact of the firm's financial leverage on its WACC and its related risk.