Question

The Comic Book Publication Group (CBPG) specializes in creating, illustrating, writing, and printing various publications. It is a small but publicly traded corporation. CBPG currently has a capital structure of $12 million in bonds that pay a 5% coupon, $5 million in preferred stock with a par value of $35 per share and an annual dividend of $1.75 per share. The company has common stock with a book value of $6 million. The cost of capital associated with the common stock is 10%. The marginal tax rate for the firm is 33%. The management of the company wishes to acquire additional capital for operations purposes. The chief executive officer (CEO) and chief financial officer (CFO) agree that another public debt offering (corporate bonds) in the amount of $10 million would suffice. They believe that due to favorable interest rates, the company could issue the bonds at par with a 4% coupon. Before the Board of Directors convenes to discuss the debt Initial Public Offering (IPO), the CFO wants to provide some data for the board of directors’ meeting notebooks. One point of the analysis is to evaluate the debt offering’s impact on the company’s cost of capital.

Solve for the new cost of capital, assuming the $10 million bond issued at par with a 4% coupon.

Answer 1

Provide narrative and solve for the new cost of capital (WACC)

We will follow the similar approach as before but this time we will include the new debt also. Please see the table below:

Component	Value	Weight (W)	Pre tax cost	Tax rate	Post tax cost	Component cost
		Value / Total	A	T	B = A x (1 - T)	W x B
Old Bonds (D1)	12	36.36%	5.00%	33%	3.35%	1.22%
New Bonds (D2)	10	30.30%	4.00%	33%	2.68%	0.81%
Preferred Stock (S)	5	15.15%	5.00%		5.00%	0.76%
Common Stock (E )	6	18.18%	10.00%		10.00%	1.82%
Total	33					4.61%