The Ewing Distribution Company (EDC) is planning a $100 million expansion of its chain of discount service stations to several neighboring states. This expansion will be financed with debt, preferred stock and equity. The firm's has 20,000 bonds with a $1,000 face value of current debt. The debt has a 12% coupon and 20 years remaining before maturity and is currently selling for $865. Ewing's marginal tax rate is 40%.
EDC has 100,000 shares of $50 par value $3.50 preferred stock outstanding which has a current market price of $42. Ewing's common stock paid a dividend of $2.10 per share this year and $2.00 the previous year. The current market price per share is $15, and the investment banking firm will charge a flotation fee of 10% if new shares are sold. The current risk-free rate is 7% and the market's estimated rate of return is 15%. Ewing's estimated beta is 1.2. Ewing expects to have $20 million of retained earnings available to finance the expansion.
Ewing's Balance Sheet
Debt $ 20,000,000
Preferred Stock 5,000,000
Common equity 75,000,000
$ 100,000,000
5. What component weights should you used to compute the WACC?
6. Compute the after tax cost of debt