Weighted Average Cost of Capital
A firm has determined its optimal capital structure, which is illustrated by the information below.
Source of Capital (Target Market Proportions)
Long term debt (20%)
Preferred Stock (10)
Common Stock Equity (70)
To expand operations, the firm is considering the following sources of financing its capital expenses:
Debt -The firm can sell 12-year, 1,000 par value bond paying a 7% annual coupon for $960. To issue the bond the firm will have to pay bond issuance or flotation cost of 2 percent of the face value of the bond.
Preferred Stock- the firm has determined that it can issue preffered stock at a par value price of $75 per share. The stock will pay $10 annual dividend. The cost of issuing and selling the stock is $3 per share.
Common Stock: A firms common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74. The firms dividends have been growing at a constant rate of 4% per year for the last four years and are expected to sustain that growth rate thereafter.
New common stock issue- if the firm decides to issue new common stock, its underwriter indicated that the issue will have to be underpriced by $1 below the current share price. Further, the firm will have to pay $1 per share in issuance or floatation cost.
Additionaly, the firms marginal corporate tax rate is 40 percent.
(Given the information above)
A) find the firms before-tax cost of debt financing
B) find the firms after-tax cost of debt financing
C) find the firms cost of preffered stock financing
D) find the firms cost of financing using the retained earnings
e) find the firms cost of financing using a new common stock issue
f) find the firms weighted average cost of capital, if the firm uses debt, preffered stock and retained earnings to finance its investments. Given this result, explain what rate of return the firm should require from its investors.
g) Find the firms weighted average cost of capital, if the firm uses debt, preffered stock, retained earnings, and new stock issue to finance its investments. Given this results, explain what rate of return the firm should require from its investments.