Question

P9-17 (similar to) Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 50% long-term debt, 10% preferred stock, and 40%, common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 23%. Debt The firm can sell for $1030 a 18-year. $1,000-par-value bond paying annual interest at a 6.00% coupon rate. Allocation cost of 2.5% of the par value is required. Preferred stock 8.00% (annual dividend) preferred stock having a par value of $100 can be sold for $96. An additional fee of $4 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for S90 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.25 ten years ago to the 54.22 dividend payment. Do that the company just recently made. If the company wants to issue new new common stock, it will sell them $2.00 below the current market price to attract investors, and the company will pay $2.50 per share in flotation costs a. Calculate the after-tax cost of debt. b. Calculate the cost of preferred stock. c. Calculate the cost of common slock (both relained earnings and new common stock). d. Calculate the WACC for Dillon Labs. a. The after-tax cost of debt using the bond's yield to maturity (YTM) is %. (Round to two cocimal places.) Enter your answer in the answer box and then click Check Answer. 6 parts remaining Clear All Check Answer Check Answer

Answer 1

a). To find the kd, we need to put the following values in the financial calculator:

INPUT	18		-[1030-(2.5%*1000)] = -1005	6%*1,000=60	1,000
TVM	N	I/Y	PV	PMT	FV
OUTPUT		5.95

Hence, kD = 5.95%

After-Tax kD = kD x (1 - t) = 5.95% x (1 - 0.23) = 4.58%

b). kP = Annual Dividend / Current Market Price

= [8% * $100] / [$96 - $4] = $8 / $92 = 0.0870, or 8.70%

c). g = [$4.22 / $2.25]^1/10 - 1 = 0.0649, or 6.49%

kE = [D1 / P0] + g

= [{$4.22 * (1 + 0.0649)} / ($90 - $2.50 - $2)] + 0.0649

= [$4.49 / $85.50] + 0.0649 = 0.0526 + 0.0649 = 0.1175, or 11.75%

d). WACC = [wD x After-Tax kD] + [wP x kP] + [wE x kE]

= [0.50 x 4.58%] + [0.10 x 8.70%] + [0.40 x 11.75%] = 2.29% + 0.87% + 4.70% = 7.86%