The Horizon Corp. has 40 million shares of common stock with a current market price of $14.00 per share. They have $270 million in par value of long-term bonds outstanding that currently sell for $935 per $1,000 par value. The bonds have a coupon rate of 7.6% and a maturity of 20 years. Assume annual coupon payments. Horizon also has $120 million in par value of preferred stock with a current market price of $108 per $100 of par value. The dividend on this preferred stock is $8.80 per year. Flotation costs on new preferred stock will be about 3%.
The dividend on common stock in the most recent year (i.e. D0) was $0.60. The firm has a growth rate of 4.5% that is expected to continue indefinitely into the future. On new common stock flotation costs would be about 8%. Flotation costs on new bonds would be negligible.
Assuming a combined state and federal marginal tax rate of 40%, estimate Horizon’s cost of capital. Calculate the WACC twice. The first time, assume they use retained earnings for any expansions, and the second time, assume that they use new common stock. The only thing that will change the second time you calculate the WACC is the cost of common equity.