Based on the information provided below, calculate the cost of debt, cost of preferred stock, and cost of common stock for Tom's Tomato Sauce, Inc. After calculating the cost of each capital component, use the answers obtained in sections A, B, and C to determine the weighted average cost of capital (WACC).
Capital components are as follows: debt 35% (tax rate 40%); preferred stock 15%; common stock 50%.
A. Debt (be sure to show all financial calculator inputs in your work)
Non-callable bonds currently outstanding pay an annual coupon of $70, have 12 years remaining until maturity, and are currently selling in the market for $1,150. (Tax rate is 40%.)
B. Preferred Stock (be sure to show the formula in your work)
Preferred stock currently pays a dividend of $ 2.70, and are trading at $33.00 per share.
C. Equity (average three to arrive at cost of equity – be sure to show the formula in your work)
CAPM approach: The risk-free rate = 3%, the market rate = 8%, and the firm’s beta = 1.2.
Bond-yield-plus-risk-premium approach: Use the bond yield calculated in A (above) and a risk premium of 4%.
Discounted-cash-flow-approach: The most recent dividend (D0) was 4.19, the dividend growth rate is 4%, and the capital gain growth rate is 4%; stock is currently trading at $50 per share.
WACC calculation (be sure to show the formula in your work):